If Argentina were in a high-stakes chess match, the country’s actions this week would be the equivalent of flipping over all the pieces on the board.
For three weeks, Argentina has been in default, unable to pay the holders of its sovereign debt because of a U.S. District Court ruling. So it’s resorted to a form of Calvinball, attempting to change the rules mid-stream to escape its predicament.
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The thing is, Argentina is kind of allowed to play Calvinball; it’s a side benefit of being a country. By definition, sovereign nations get to make up their own laws and even alter them on a whim. If they don’t want to obey the dictates laid down by other countries or international norms, there’s only so much the international community can do about it.
Which is why expecting U.S. courts to unilaterally delineate Argentina’s payment schedules was predictably impossible. They should have never inserted themselves in the first place into what is little more than a hedge fund’s moneymaking scheme. And Argentina’s response, however unorthodox and bizarre, might even help the U.S. economy, in a cock-eyed way.
Here’s the story so far: Due to fiscal mismanagement, Argentina defaulted on its debt obligations in 2001. The successor government negotiated a deal, where bondholders would take a significantly reduced payment. About 92 percent of the country’s creditors accepted this as the least-worst result, and Argentina has not missed a payment to them since then.
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However, a few rogue hedge funds, led by Paul Singer’s Elliott Capital Management, started buying up Argentine debt at a severe discount, in a bid to make some easy cash by using U.S. courts to force Argentina to pay full value on the bonds. This activity is properly described as the work of “vulture funds,” who hover over failing companies or countries and try to profit off their suffering.
After years of legal wrangling, the vultures found a judge willing to enforce their terms. Judge Thomas Griesa ordered Argentina’s bond trustee, Bank of New York Mellon, to withhold payment to the bondholders that accepted the deal until the vulture funds got paid. The Supreme Court declined to take the case, letting Griesa’s ruling stand. Failing to reach agreement with the vultures and unable to pay its bondholders, Argentina slipped into default on July 31.
Argentine President Christina Fernandez Kirchner then made the startling announcement that she would ask the country’s legislature to approve a scheme to fire Bank of New York Mellon and service debt through a local account at Banco de la Nación in Buenos Aires. This way, debt payments would not be governed by U.S. law and not subject to the court order. Bondholders who want their money, in effect, would have to go to Argentina and get it. They would have to voluntarily swap their bonds issued under U.S. law with the new Argentine bonds, which the government could pay immediately.
An ocean of questions accompanies this scheme. First of all, Bank of New York Mellon would have to agree to cancel the old bonds when bondholders agree to the new terms; otherwise you would have two sets of bonds floating around. Given Bank of New York Mellon’s obligations under U.S. law, Judge Griesa (who has already described the debt swap as illegal) could hold them in contempt for abetting a countermand of his ruling. In fact, the bondholders may be liable to a charge of violating the judge’s order if they try to collect their payments in Argentina.
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The fact that prices on Argentine bonds collapsed, for the first time since default, upon the announcement, testifies to the deep skepticism over it.
This may all may be a political move by Kirchner to dare her opponents to vote against the plan, effectively aligning themselves with an unpopular U.S. ruling and an even more unpopular vulture fund. But the larger message from the Argentine government is that it will plainly not accede to the demands of another country’s court and hand over full-value payment to the vulture funds. Argentina believes that payment would make it liable to future claims from all of its bondholders for more money. Already the country has no presence in international debt markets, so it cannot operate as leverage. And it sees fighting the order as a better option for its nation and its economy than agreeing to it.
U.S. courts, as well as the plaintiffs, don’t have much recourse to deal with such defiance. They do not have control over how another country manages its affairs. As proof of the frustration, a group of Wall Street banks have attempted to buy out Elliott and its colleagues, with the idea of negotiating with Argentina to settle the matter. Elliott has overplayed its hand against an opponent who doesn’t much care about the consequences.
That’s why Judge Griesa should never have gotten involved. As Georgetown law professor Adam Levitin explained weeks ago, Griesa bungled into this case without having any way to bind Argentina to his dictates. Griesa can actually only make the situation worse, by preventing payment; he cannot mandate it, as long as Argentina doesn’t want to pay. The bonds may be governed by U.S. law – but Argentina is not. Courts should and typically do shy away from such intractable situations, especially when they’re intervening on behalf of a vulture fund that fully knows the risks of trying to extract profits from distressed debt.
There’s a larger lesson here. Under Judge Griesa’s precedent, no bondholder would have any incentive to accept less than full payment no matter the situation, a crippling scenario for sovereigns or even corporations trying to survive the process of renegotiating their debt. Bankruptcy and debt renegotiation are normal alternatives that would be cut off if any creditor can simply get a judge’s ruling to force payment.
“No credit system has ever functioned with zero default,” explains Jayati Ghosh, economics professor at Jawaharlal Nehru University in India. “The ruling actually negates the basic principles upon which all credit markets function.”
But if vulture funds like Elliott face huge problems with trying to get sovereign nations to pay up, even when they get a favorable legal ruling, maybe they won’t see it as such a worthwhile enterprise. That would be positive. It would restore the primacy of debt renegotiation as a tool in all contracts. It would allow for markets to price risk with an interest rate instead of with whatever legal argument they can make.
And as certainty beats uncertainty where payments are concerned, it makes for a better economy in the future. Creditors will feel more comfortable to lend if they know that they may take on some risk, but that they won’t get their payments caught in a hedge fund-led game of cat-and-mouse.
Argentina’s gambit can reasonably be described as crazy. But sometimes, crazy can work wonders.
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