A new Argentinian default?

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While there is much to reproach the present Argentinian government (which we have done here and here), Lisette Lewin of the Business Insider depicts a particularly one-sided picture of Argentina's efforts to stave off a new default on it's public debt. Some examples:

On Monday, Argentina's Economy Minister Axel Kicillof will meet with a special master of the court to negotiate his country's debt with a group of hedge fund creditors, and right now that makes him — an economist with a strong Marxist ideology — the most dangerous politician in Latin America.

The Most Dangerous Politician In Latin America - Business Insider

Argentina has its back against a wall. On July 30 it may default on a sovereign-debt payment that could send its economy into a tailspin of rising interest rates, money printing, and inflation. It could be the worst economic tragedy the republic has seen since 2001. And the tragedy will be well deserved, because this is a drama of Argentina's own making

Argentina Is Getting Exactly What It Deserves - Business Insider

Little has been written about how it went, but based on the chilling op-ed Kicillof posted on President Cristina Fernandez de Kirchner's website on Tuesday, we can only imagine that things went badly.

Kicillof Op-Ed After New York Meeting - Business Insider

Apart from the fact that Kicillof is hardly a "hard-line" (or even a soft-line) marxist, or the most dangerous politician in South America, the picture in these articles is a bit one sided. A few facts:

• Argentina defaulted on its debt in 2001, a truely traumatic event in which a significant part of the middle class was reduced to poverty and the economy got in a tailspin
• It restructured the outstanding debt in 2005, and then again in 2010, 93% of original bond holders participated in the combined restructuring. 7% didn't, these are the hedge funds that bought these bonds on the cheap after the default, for pennies on the dollar
• The holdouts, as the 7% are known went to considerable length through the American courts to get 100% of the face value of the bonds back, something which would mean a big multiple on their investment. It's indeed they that didn't want to negotiate.

The holdouts have essentially won these cases, forcing Argentina to pay them in full, something in the order of $1.3B, manageable in and by itself, but there are important ramifications:

• Argentina cannot now pay its "93%" holders (the ones who participated in the restructuring) without paying the holdouts
• If the 7% holdouts can get the full face value of their bonds, it's likely that the other 93% can claim this as well ("pari passu", which would be a financial disaster for Argentina and essentially nullify the 2005 and 2010 debt restructurings
• What's more, it will put in danger any sovereign bond restructuring, as holdouts now have legal recourse.

Just like people and corporations sometimes need orderly restructuring of their debt, so do countries, but there are no bankruptcy courts for countries. The process relies on the market, which gives people an incentive to hold out (or even buy bonds after the restructuring, as Singer did).

There are bonds which have a collective action clause, which put the bar for restructuring without legal recourse at less than 100%, but the pre-2001 Argentinian bonds do not have these.

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Here is the letter from the "most dangerous politician" in Latin America (according to Linette Lopez of Business Insider)

Vulture funds are showing their true colours

From Mr Axel Kicillof.

Sir, I am writing to set the record straight regarding Jay Newman’s opinion piece (“We holdouts are open to compromise but Argentina has to talk”, Comment, July 8).

Elliott Management Corporation’s NML Capital purchased Argentine bonds in 2008 and immediately sued Argentina. These bonds, defaulted in 2001, were bought with the sole purpose of obtaining a favourable judgment to make an exorbitant profit.

Mr Newman wants to portray Argentina as a country that does not negotiate. This is outright false. Following lengthy negotiations, Argentina offered two debt exchanges, in 2005 and 2010, which were voluntarily accepted by 92.4 per cent of the country’s bondholders.

The vulture funds never negotiated. They never lent money to Argentina. NML purchased bonds at a value close to $50m.

US District Judge Thomas Griesa’s order would allow NML to cash more than $800m, securing it a 1,600 per cent yield in only six years. If instead of litigating NML had accepted the debt exchanges offered by Argentina, it would have tripled, or even quadrupled, its investment.

Argentina has made clear its willingness and capacity to negotiate since 2003. After an unjust ruling by US courts, earlier this week I met Daniel Pollack, the special master appointed by Judge Griesa, proving our willingness to move forward in a dialogue to ensure fair, equitable and legal conditions, taking into account the interests of 100 per cent of bondholders.

Argentina has requested the reinstatement of the stay order. The vulture funds opposed the petition, showing their true colours – they do not want to negotiate; they either get their claim in full or try to force Argentina into default. But this will not happen: Argentina will defend its successful debt restructuring process by paying its bondholders. What kind of equitable negotiation, involving hundreds of billions of dollars, can be conducted in only three weeks?

The vulture funds never wanted to abide by the terms accepted by the overwhelming majority of creditors. They seek to extort a sovereign country. They want privileged conditions and they will stop at nothing: they will interrupt a flow of payments to Argentina’s exchange bondholders denying these bondholders property that is rightfully theirs; they will speculate with the future of 40m Argentines; they will cause irreparable damage to the international financial system rendering all future debt restructurings impossible.

This is why the international community is standing with Argentina’s position in this case.

Vulture funds do not negotiate: that is why they are vultures.

Axel Kicillof, Minister of Economy and Public Finance of Argentina, Buenos Aires, Argentina

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And here is Martin Wolf, respectec columnist from the FT:

Defend Argentina from the vultures

By Martin WolfAuthor alerts

A creditor paid more to take on the risk of a default cannot then be surprised by it

Not far from the London offices of the Financial Times was the Marshalsea prison where debtors used to be sent. In the 18th century, more than half of London’s prisoners were incarcerated for their undischarged debt. The moral hazard Taliban of the day insisted that such harsh penalties were necessary. Then, in 1869, imprisonment for debt was abolished and bankruptcy introduced. Both economy and society survived.

Things sometimes go wrong. Sometimes this is due to bad luck and sometimes to irresponsibility. But society needs a way to allow people to start over again. This is why we have bankruptcy. Indeed, we allow the most important private actors in our economies – companies – to enjoy limited liability. This lets shareholders walk away from their companies’ debts unscathed. That idea, too, was condemned as a licence to irresponsibility when introduced. Limited liability does bring problems, notably in highly leveraged businesses (such as banking). The ease with which US corporations can walk away from their creditors is breathtaking. But this is better than unlimited liability.

A similar logic applies to countries. Sometimes their governments borrow more than they turn out to be able to afford. If they have borrowed in domestic currency, they can inflate their debt away. But if they have borrowed in foreign currency, that possibility disappears. Usually, it is countries with a history of fiscal irresponsibility that find themselves obliged to borrow in foreign currencies. The eurozone has put its members in the same position: for each government, the euro is close to being a foreign currency. When the costs of servicing such debts become too high, then restructuring – default – becomes necessary. As Carmen Reinhart and Kenneth Rogoff of Harvard University showed in This Time is Different, this is an old story.

As I argued at the time, Argentina found itself in this position at the turn of the century. It was difficult to feel much sympathy for the country, which suffered from chronic mismanagement before its default in December 2001 and was to suffer yet more thereafter. But it had become impossible to service its public debt of $132bn at tolerable cost. Moreover, creditors had been rewarded for the possibility of default. Even at its lowest point, in September 1997, the spread of Argentine dollar bonds over US Treasuries was close to three percentage points. A creditor compensated for the risk of a default cannot be surprised by it. The solution is portfolio diversification.

While the principle of sovereign debt restructuring is compelling, in practice it is difficult. No court can seize and then liquidate a country’s entire assets. This legal limbo creates two opposing dangers: the first is that it is too easy for a country to walk away from its debts; the second is that it is too hard. The Argentine story illustrates both: confronted with an intransigent government, holders of 93 per cent of defaulted debt accepted exchanges for debt with a hugely reduced face value; but “holdouts”, who reject such an exchange, have blocked a clean resolution. The mess has lasted more than 12 years from the default.

As first deputy managing director of the International Monetary Fund, Anne Krueger advanced a proposal for a sovereign debt restructuring mechanism in 2002. She argued that the restructuring process could be delayed or blocked if some creditors were able to hold out for full payment.

Her ideas were more supranational than governments – above all, the US – could bear. But “collective action clauses” were at least introduced. Yet such clauses might not have prevented the success of holdouts over Argentina, led by Paul Singer of Elliott Management. As the IMF recently noted, these clauses “typically only bind holders of the same issuance”. A holdout creditor can “neutralise the operation of such clauses” if they secure a blocking position, normally more than 25 per cent.

Moreover, adds the IMF, US courts have interpreted a “boiler plate provision” of these contracts (the so-called pari passu clause) as requiring a sovereign debtor to make full payment on a defaulted claim if it makes any payments on restructured bonds. In addition, the US courts will force financial intermediaries to help creditors obtain hold of the sovereign’s assets. All this will make restructurings harder. Why should creditors accept an exchange for instruments with reduced value in future?

I am no lawyer, but to me the idea of equal treatment means treating like cases in the same way. Yet creditors who have accepted exchanges and holdouts are not like cases. To force debtors to treat them equally seems wrong. Moreover, the argument that holdouts are helping Argentines by punishing government corruption is absurd. It is up to Argentines to choose the government they desire. Worse, if Argentina is forced to pay holdouts in full, the price will be borne by Argentines. This is extortion backed by the US judiciary.

The immediate issue is how Argentina might settle these cases. The options – paying the holdouts, reaching a deal with them, transferring restructured debt into domestic law and outright default – look costly, humiliating, difficult or damaging. Worse are the longer-term implications for debt restructurings.

One possibility is to eliminate the pari passu clause. Another is to introduce stronger collective action clauses, particularly ones that cover all outstanding instruments. Another is to shift issuance from New York. But all three would apply only in future. Another possibility would be to amend US law. A final possibility, as José Antonio Ocampo of Columbia University notes, is to revive the idea of a global mechanism. These last two options look very unlikely.

Yet in a world of global capital flows, a workable mechanism for restructuring sovereign debt is not an optional extra. It is possible that Argentina is an exceptional case. It is more likely that the interpretation of the pari passu clause and the ability to pursue assets will now make it more difficult to restructure debt. A world in which the choice for sovereigns and their creditors is between full payment and absolute non-payment would be as bad as one in which debtors had to choose between starvation and prison. A better way must now be found.

martin.wolf@ft.com

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It seems to us that if Argentina's economy minister is so dangerous, so is Martin Wolf, widely respected columnist from the Financial Times..