The Rubble of Argentina’s Debt Settlement
After a 14-year standoff, Argentina has agreed to settle with the biggest holdout creditors who bought bonds on which it defaulted in 2001, letting the new government in Buenos Aires resume the life of an ordinary sovereign in the global capital markets. The $4.65 billion settlement follows more than a dozen agreements with smaller holdouts since the start of 2016 and estimated at over $1.5 billion. It is good enough for Argentina, and very good indeed for some of the holdouts—but the entire episode, and its conclusion, is bad for the rest of the world and for the international financial system.
In the years of lawsuits, negotiations, and wrangling after its default on more than $80 billion in foreign debt, Argentina agreed to pay 93 percent of its bondholders about a third of what they were owed. Among the creditors it failed to win over were funds that bought the debt at a discount and sued to get paid in full. Thanks to a court ruling that no one could get paid until they got all their money, some of these funds reportedly stand to get a cash payment 15 times their initial investment. Holdouts who stand to collect three to five times their investment look like poor cousins by comparison, while the vast majority of Argentina’s creditors who agreed to deep debt forgiveness years ago in exchange for approximately $30 billion in new bonds might be filled with regret, even though most have recouped their principal by now.
The best that can be said about this settlement—if it goes through as planned in April—is that it promises to contain the damage the fight between Argentina and its holdout creditors has already done to the international financial system.
The worst thing about it is that the case has produced and tested an immensely potent weapon that a small minority of creditors can now use to hold countries and the rest of their creditors hostage.
After a decade of feckless efforts to get Argentina to accede to holdouts’ demands for preferential payout, a US federal judge issued an injunction effectively blocking the government from paying its restructured debt or issuing new debt to replenish its foreign exchange reserves—not even in London or Buenos Aires, not even under Argentina’s own law. The court did so by targeting market intermediaries—trustees, payment systems, clearinghouses around the world—which, unlike the government of a sovereign country, could ill afford to jeopardize their business in New York. This was a weapon that worked entirely by inflicting collateral damage, even as the court was “bemoaning” its effects on “entirely innocent third parties.”
Some still claim that this injunction was unique to Argentina and is no precedent for other countries. This is disingenuous, sloppy, or both. No one has suggested that the case could not be cited in future briefs or judicial opinions as good authority in the Second Circuit, where much of global financial contract interpretation and enforcement takes place. The argument is, rather, that no country would reach Argentina’s level of “contumaciousness” (a term used by the courts, whose newfound popularityis among the few good things to come out of the 14-year legal fight). When he decided to dissolve the injunction, the judge who had issued it said, pointedly, that Argentina’s example “might even encourage other indebted nations to choose compromise over intransigence.” And so it might. Countries may settle sooner, on terms more favorable to the free riders, to avoid Argentina’s fate. Banks and clearinghouses will think twice before dealing with sovereigns whose populist leaders spew invective at thin-skinned financiers and judges—or who simply refuse to do as they are told. In other words, the precedent could turn out to be so powerful that the mere threat of invoking it would make countries stand down.
On the other hand, the injunction and the settlements might compel more creditors to hold out and try their hand at creative litigation tactics. Who can blame them, if the choice is between holding out for 1,500 percent returns or taking 33 cents on the dollar, which might be blocked by the holdouts anyway. The latest settlement very publicly rewards the largest group of holdout creditors of any sovereign debt restructuring in modern memory. No longer can the possibility of a few free riders lying in wait for ages and collecting astronomical profits be dismissed as a minor irritant, a minuscule tax paid by the country and the majority of its creditors to model market discipline and commitment to repay. In the end, the holdouts as a group may get a cash payment of more than a quarter of the outstanding principal of restructured bonds. With the injunction template readily available, validated by US appeals courts, and tested in action, holding out is no longer a wild, exotic gamble—it is a viable, marketable investment option. Stalled negotiations and prolonged crises could well be the result.
What of those contract reforms that courts and government officials have touted as a market-friendly, consensual way of insulating future sovereign borrowing from Argentina’s fate? New improved collective action clauses in sovereign bonds will, in the long run, empower creditor majorities to impose similar terms on all similarly situated creditors, sharing the burden and foreclosing free riders. The long run here is long indeed: According to a survey by the International Monetary Fund, only 6 percent of outstanding international bonds have these clauses. It will take more than a decade for the $900 billion stock without the clauses to turn over. Even then, all it takes to free ride in a world of reformed contracts is one stray unreformed bond: The injunction allows a single creditor who is not swept up in the stockwide majority vote to block payments to everyone else. It is designed to reward free riding handsomely.
The settlement also casts the courts in a sad light for allowing themselves to be dragged into a no-win battle between a sovereign debtor they could not control and sophisticated creditors that deftly manipulated judges’ frustration with being snubbed by populist politicians. Instead of adjudicating the dispute, the court became a combatant. The latest settlement in no way vindicates the court’s contract interpretation, the injunction that enforced it, or the sanctity of contracts in whose name it was pursued. Had the old government remained in power, there likely would have been no settlement. Had a new government come to power five years earlier, there likely would have been no injunction. As the court and the special master have said, the election “changed everything.” Would the creditors and the US judiciary want to take credit for the change in government?
Finally, the settlement makes a mockery of all notions of equity and equality. The stated purpose of the injunction was to enforce equal treatment among similarly situated creditors, as promised by Argentina in its 1994 contracts. The court purported to construe the meaning of equal treatment in the injunction, but the result could only make sense in Newspeak: Recoveries for similarly situated creditors will range from 100 to 1,000 percent of original bond principal, depending on their contract interest rates and whether they had obtained court judgments. The disparities are gaping, not only between restructured and holdout bonds but also among the holdouts, some of whom accrue annual interest at 101 percent, while others get the interest rate on a one-year US Treasury note. This outcome exalts sophistication and chutzpah; it punishes trust and cooperation.
Judicial discretion is supposed to involve judgment and promote fairness where formalistic enforcement of contract text comes up short. In this case, it did exactly the opposite.
So let’s break out the champagne. The damage is done.