World Cup of Default: Argentina at T-Minus 19

Despite its tremendous natural wealth, Argentina has long been the poster child of underdevelopment. Aside from the sporting conquests of its racing car drivers (think Juan Manuel Fangio) and footballers (Diego Maradona or Lionel Messi), it's better known in economic circles for lurching into crises with some regularity. Off the playing field, the economic fortunes of the World Cup finalists Germany and Argentina could not be more different. The winners of the World Cup will win a cool $35 million in prize money, so now may be a good time to root for Argentina (assuming that its football association gives the money to the rather broke government). Then again, Argentina may need far more than the measly $28 billion or so it has left in its foreign exchange reserves depending on how its impending default is resolved.

To make a long story short, Argentina has nineteen days to sort out how it will make interest payments to its creditors, or it will default when August comes around."Bang on schedule" some say as the country has a crisis of some sort every decade. This time, though, impending default is not entirely its fault. True, retro-socialist policies have sunk it into the mire of recession--what else is new? All that fudging of the books--the IMF wanted to show it a football-esque "red card" for inappropriate conduct--has not concealed its state of penury from anyone.

Chaotic finances aside, Argentina's current situation has been exacerbated by the legal machinations of American hedge funds (characterized as "vulture funds" by the Argentine government). After defaulting on about $95 billion in debt at face value in 2001, Argentina renegotiated $62.3 billion worth of outstanding debt in 2005 down to a value of $35.2 billion with private creditors. In financial lingo, the creditors received a "haircut." In 2010, another $12.4 billion worth of private debt was renegotiated along similar terms.Together they represented 93% of all creditors. That left Argentina with a touch under $10 billion worth of debt to holdouts. (The rest was sovereign debt AKA "Paris Club".)

It is this non-renegotiated amount that is currently causing Argentina trouble. In 2008--well after the first round of renegotiations were held--hedge fund NML Partners speculated on this "distressed debt" by buying bonds that were not renegotiated at a dirt-cheap price:

[H]owever, a handful of hedge funds purchased the bonds after the default when they were at deep discounts. Since then, they have repeatedly demanded to be paid at 100 per cent of their face value. This is considered by many as predatory. For example, NML Capital purchased the majority of their Argentine bonds from June-November 2008, paying an estimated $48.7 million for over $220 million in defaulted bonds, a price of just over 20 cents on the dollar.

NML Capital and company have used legal machinations--forum shopping--to get the result it desires in a lower New York court since the original default is covered by New York law. (The US Supreme Court has since refused to hear the case.) By resorting to the US legal system, the hedge funds obtained a favorable ruling that compels Argentina to pay them at face value before compensating those who had renegotiated their bonds. The difficulty now facing Argentina is that it is was due to pay bondholders of the restructured debt this month. However, it cannot do so since it courses its payments through the Bank of New York-Mellon which is a well-known correspondent bank (that which specializes in handling payments for transactions). Poor BNY-Mellon is being hit by all sides since it obviously cannot make the interest payments due to restructured debt holders due to court order:

It’s been a fun week for Bank of New York Mellon. The bank is getting lawsuit threats left and right from just about everyone involved in the Argentina debt dispute. “Nearly economic stakeholder in this litigation has either sued or threatened to sue,” the bank said in a letter from BNY’s lawyer filed to the U.S. District Court last night.

The reason is because BNY is still holding onto some $539 million deposited by Argentina with the bank on June 26. The deposit was Argentina’s attempt to get around a U.S. court ruling that said the country is not allowed to pay its restructured bondholders, who had an interest payment due June 30, until it pays a small group of holdout creditors. Argentina deposited the interest payment anyway, even though it hadn’t paid the holdouts.

The question occurs: why not pay the $15 billion or so claimed by the holdouts and be done with it once and for all? Argentina still has (an admittedly measly) $28 billion in reserves, right? Doing so would invoke a clause in the contract with the holders of restructured debt that improved terms offered to others would be extended to them. In other words, the face value of Argentina's principal obligations would return to $95 billion (less that owed to sovereign lenders) as if the haircut never took place upon paying the holdout creditors at face value.

The UN Conference on Trade and Development (UNCTAD) summarizes the negative precedents this case sets:

• First, by removing financial incentives for creditors to participate in orderly debt workouts, the rulings will make future debt restructuring even more difficult, in particular for outstanding bonds without a Collective Action Clause, the actual amount of which is unknown but is likely to be large.
• Second, obligating third-party financial institutions to provide information about assets of sovereign borrowers will have a significant impact on the international financial system as it forces financial service institutions to provide confidential information on the sovereign borrower's global financial transactions to facilitate the enforcement of debt contracts for the creditors.
• Third, the ruling will erode sovereign immunity.

I am, remarkably, in agreement with UNCTAD that the world needs a centralized process for handling debt workouts so complications like these wrought by profiteers and opportunists are avoided. In others words, close off the numerous avenues for forum shopping that still exist. This impasse reminds me of movies where all the main characters are antagonists: Save for the innocent bystander BNY-Mellon, the New York lower court, US Supreme Court, the hedge funds, and the government of Argentina are unsavory characters all around.

If this impasse is not resolved by month's end, Argentina will indeed by partying like it's 2001. As the lyric goes, I was dreaming when I wrote this, forgive me if it goes astray...

UPDATE 1: Lest you think football and default are not on Argentine fans' minds, Bloomberg suggests otherwise judging from their chants:

But a less traditional song could also be heard in the streets of Rosario, Argentina’s third-biggest city and the birthplace of team captain Lionel Messi: a profanity-laced taunt of the hedge funds that have battled the government over defaulted debt since 2001. “Vulture funds,” a group chanted amid celebrations at the city’s National Flag Memorial. “Stop messing around and agree to the swap.”

The chants underscore how the country’s decade-old legal dispute with holdout creditors is still capable of stirring up nationalistic passions among Argentines. The U.S. Supreme Court last month left intact a ruling that may cause the nation to default on July 30 unless it can reach a settlement with the funds, which are led by billionaire Paul Singer’s Elliott Management Corp. The investors rejected government exchange offers that imposed 70 percent losses after the record $95 billion default, suing for full repayment instead. 

UPDATE 2: One of the holdouts, fund manager Jay Newman at Elliott Management Corporation, says that some of them purchased Argentine bonds before the 2001 default and that the government has refused to negotiate terms with them ever since, offering the take-it-or-leave-it deal described above. It is the other side of the story:

Our firm began buying Argentine bonds long before its default. We joined thousands of others in declining Argentina’s coercive bond-exchange offers, which imposed steep losses on holders. As the International Monetary Fund noted: “No constructive dialogue was observed and the authorities presented a non-negotiated offer.”

In the contract Argentina signed in 1994, it promised to rank its payment obligations on the original bonds equally with any new external debt, and to submit to the jurisdiction of US courts. Without these promises, a country that had earned a reputation as a serial defaulter could not have borrowed on such attractive terms.

Argentina's Finance Minister Axel Kicillof says Jay Newman is distorting matters, though:

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.

On one hand, I believe that the bulk of the Elliott Management Corporation purchases were made post-default. OTOH, Argentina did not "negotiate" but largely devised terms of the debt restructuring by itself. Both sides dabble in half-truths. As I said, there are no protagonists here.

UPDATE 3: Notice how Argentine President Cristina Fernandez did not attend the World Cup final for the lame reason that it was her grandson's birthday....on Monday. (Contrast her with Angela Merkel who flew halfway around the world just to be there for the finals.) Either (a) she knew the odds were against Argentina or (b) the flak that would accompany her being at a loss would add further pressure on her as Argentina nears another default. It is now T-18 and counting from where I'm writing..