It is difficult not to sympathize with the government of Argentina. It says it does not wish to default on its debt, but it is being squeezed by two sets of forces: Argentine domestic law and the overwhelming majority of its creditors on one hand, and a New York court and a small group of creditors that refuse to negotiate what they are owed on the other. Another default looks more likely each day.
In 2001, Buenos Aires defaulted on about $100 billion of its debt, at that time the largest sovereign debt default in history. Over a period of several years, it negotiated with holders of the original securities and agreed to swap the old bonds for new ones worth about 33 cents on the dollar.
Ninety-three percent of the defaulted bonds were swapped. The remaining 7 percent refused to renegotiate and demanded payment in full, a position that the Argentine government argued was manifestly unfair to those creditors who did agree to the haircut.
That position was backstopped by Argentine law and a clause in the restructured bonds agreement, both of which guarantee exchange bondholders that the government will not make a better offer to investors who did not participate in the restructurings.
Unbowed, the minority have continued to fight for payment in full. They have looked all over the world for Argentine assets to seize, and once even got an order to impound an Argentine Navy vessel. They have even demanded that courts disclose the location of those government assets.
According to Argentine government officials, the country has been the target of more than 900 creditor lawsuits.
On June 16 the U.S. Supreme Court refused to hear an appeal of the New York District Court ruling that Argentina had to pay the holdouts along with the restructured bondholders when it made the interest payments due June 30. Argentina promptly asked for a delay to negotiate, a request that was just as quickly refused by the New York judge.
To up the ante, the judge also issued an injunction that forbade New York banks, which act as the conduit for the government’s payments to bondholders, from paying some debt and not others.
In many ways, Argentina is not a very sympathetic plaintiff. It dismisses the holdout bond holders as “vultures” and President Cristina Fernandez de Kirchner has said her country would not bow to “extortion.”
Economy Minister Alex Kicillof claimed the court rulings aim to “bring us to our knees before global usurers.” Leaked correspondence between Argentina and its lawyers suggests that their legal strategy might involve “gaming the system” to sidestep the judge’s ruling.
But overheated rhetoric aside, Kicillof has a fairly accurate assessment of the situation. The Argentine economy is slowing and inflation is rising. Central bank reserves have fallen to eight-year lows and are now about $29 billion; they are likely to shrink still further in the second half of the year.
With potential exposure to the holdout creditors reaching as high as $15 billion, or half the country’s reserves, this debt ruling could force yet another default.
“Force” is the operative term. Argentina is ready to pay the holders of restructured bonds. It deposited $832 million at New York banks to make interest payments due June 30, but the judge’s ruling makes that partial payment impossible. Failure to do so means that the country is technically in default on June 30, but it will have a one month grace period to negotiate some resolution before the default is final.
The impact of the ruling extends beyond the Argentine case. The International Monetary Fund has warned of “systemic consequences” if countries shy away from giving U.S. courts, arguably the most sophisticated in the world on these matters, jurisdiction over cases for fear of a loss of sovereignty.
In a similar vein, the United Nations Conference on Trade and Development (UNCTAD) published a rare comment on the ruling that also focused on “legal precedents that could have profound consequences for the international financial system.” It noted that the ruling removes financial incentives for creditors to participate in debt restructurings, making future arrangements more difficult.
Requiring third-party financial institutions to provide information about the assets of sovereign borrowers could undermine the confidentiality that is critical to that relationship. Finally the ruling erodes sovereign immunity, a cornerstone of international diplomacy and finance.
The worries about sovereign immunity are real. The U.S. government published a “friend of the court” brief in the Argentine case warning of adverse effects on international relations if the holdouts won and Argentine law was summarily dismissed. Equally real is the prospect of retaliation against U.S. assets in aggrieved nations.
The hope now is that Argentina and the holdouts will redouble efforts to reach a settlement in the month before a real default occurs.
The U.S. government, along with other parties worried about the impact of the ruling on future debt restructurings, should press the holdouts to settle. The holders of the restructured bonds have done well; there is money to be made even after a haircut.
The holdouts’ utter disregard for the consequences of their stubborn refusal to settle deprives them of any moral claim to payment. That, and not the financial bottom line, should dictate the outcome.