Argentina and the Presentation to the Second Circuit US Court of Appeals

Argentina’s debt crisis of 2001/2002 was a profound and painful one. The 2005 restructuring proposal reflected the difficulties suffered by the country (see my blog http://www.economonitor.com/blog/2008/09/some-reflections-on-argentinas-debt-restructuring/). The acceptance reached about 74%, therefore there was still a substantial percentage of holdouts. Sometime in 2006 or 2007, and for reasons that still escape me, people from an important fund that  had not participated in the 2005 debt exchange and held a significant percentage of the about 18 billion dollars not exchanged, visited me to talk about what they should do to get to an agreement with the Argentine government (at that time I represented the Government of Argentina (GOA) at the Board of Executive Directors of the Inter American Development Bank, but, as I told my visitors, the debt issue was “way above my pay grade”).

In any case they insisted and therefore I told them four things that I thought they should do: first, they should stop bad-mouthing my country because no one would negotiate under those conditions (they said that they were not behind the aggressive and negative lobbying in Washington and other capitals that tried to present Argentina in the worst possible light; rather, they attributed the campaign to (in their words) the “cowboys from ATFA,” i.e. the American Task Force for Argentina, the lobby outfit paid by Elliot and similar funds); second, I said that they should not put pressure on international organizations to stop lending to Argentina because this would make a settlement even more difficult; third, they should present a proposal and not wait for the GOA to make a first move that was banned by an Argentine law (the “Padlock Law,” or “Ley Cerrojo”); and, fourth, they should include in their offer some new money. To my surprise, that fund put together a proposal along these lines (even with new money) but then the 2007/2008 crisis intervened, forcing the elimination of the new-money component and delaying the whole process.  However, that proposal eventually resulted in the 2010 debt exchange, which led to an overall acceptance of somewhat more than 91% (adding the 2005 and 2010 debt exchanges).

I mentioned this to highlight the differences in approaches by holdouts willing to negotiate and Elliot and company (“the cowboys from ATFA”), which maintained the aggressive lobbying campaign against Argentina that is an important reason for the bad blood between the parties. Now we are in another phase of the post-2010 drama, with the March 29 proposal by Government of Argentina (GOA) (see http://www.shearman.com/files/upload/NML-Capital-v-Argentina-2013-3-29-Letter-from-Argentina-to-the-Court.pdf).  I have I left the government of Argentina more than a year ago (see http://www.lanacion.com.ar/1454410-confirman-que-cambia-el-delegado-argentino-en-el-bid). So my comments here do not reflect official positions or special inside information.  But because I am getting increasingly frustrated by what I have read after the March 29 proposal, let me unload at least part of my frustration in the next paragraphs.

Some people complained that the offer did not present anything new with respect to the previous debt exchanges. How could have done the GOA anything different if a) it has been arguing that “pari passu” means that all bondholders must be treated equally, and that the plaintiffs do not deserve a better treatment, as would be the case under the original Judge Griesa’s ruling of a 100% payment, and b) there is still not a ruling by the Appellate Court?  On the other hand, some other people complained that the GOA should not have included the GDP coupon in this offer. Again, given that it was in the previous debt exchanges, how could the GDP coupon not have been included now?

Other people have jumped to the conclusion that because Elliot and company did not accept the 2010 debt exchange, they will not accept this offer now. The fact that yesterday (April 2) the US Court of Appeals for the Second Circuit in New York sent to the holdouts the Argentine proposal offers new perspectives.  Before, these holdouts (to avoid charged words such as “vulture funds” which according to many would better reflect the nature of the business model followed by the litigating funds) had a firm ruling in their favor. Now they need to evaluate what to do before knowing what the Second Circuit Court really thinks. The holdouts may well still reject the proposal. But I would argue that it would be a mistake. Those holdouts seem to be operating under some misconceptions about the legal, economic and political aspects of the case, at least as those issues are seen from the point of view of the GOA (my interpretation, of course). Therefore, it would be useful for them to reconsider.

*First, the current holdouts seem to think that if there is a second ruling against Argentina, the GOA will be able to make a better offer to the plaintiffs and be immune legally because it is not a voluntary offer but it would have been mandated by the Court.  This legal interpretation is completely untested, and may lead to more litigation and not less.  The GOA cannot follow this interpretation, given all the risks involved.

*Second, they seem to think that it is impossible to re-route the payments outside New York. To do so would certainly be a messy process, and it would generate uncertainty and higher risk premiums for some weeks or even a couple of months. But informed observers consider that it can be done.  I think it is obvious that the GOA wants to protect the bondholders that entered the previous exchanges.  So, in my opinion, it will do whatever is needed to make sure that any interruption is short and that current bond holders are made whole. It is interesting to mention (a fact noted by several analysts) that now Argentine bonds under Argentina’s law trade at a premium over those under New York law: i.e. markets consider that it is safer to have bonds under Argentina’s law than under New York law. The damage that the Judge Griesa’s ruling is inflicting on New York as a financial center is clear, and may become substantial if that ruling is upheld.  Even with the short-term disruption, the medium-term benefits for Argentina of ending the multiple litigations, present and potential, in New York by re-routing payments through other centers (including Argentina) may be more than the costs.  The most important medium-term costs will be borne by New York economic and financial agents, who are already unhappy with the attitude of the holdouts and with Judge Griesa’s ruling.

*Third, they seem to believe that the GOA needs to go back to the credit markets urgently, and therefore is under financial pressure to settle this claim. But this does not seem to be the case.  All estimates about large fiscal deficits are exaggerated by excluding current financing from the Central Bank and the Social Security system as if they were 100% illegitimate. Between calculations that consider such financing as 100% legitimate (as the GOA does) and 100% illegitimate (as the critics argue) there is a range of possibilities for which I have not seen reasonable analyses. In any case, the GOA still has access to that financing (whatever the medium term negative consequences of such method of funding the public sector may be) and the fiscal consolidation needed to reduce deficits to very comfortable levels is not big as percentage of the GDP.

*Fourth, Elliot and company do not seem to appreciate the depth of the dislike their business model generates in many quarters, starting with the GOA, but now including the banks and bondholders held hostage by Judge Griesa’s decision, not to mention the governments of several industrialized countries facing widespread debt problems.  The GOA may well think (and I am solely responsible for this guess) that as the 2001/2002 Argentina’s crisis led to the final generalization to the Collective Action Clauses (thus providing at least something positive for international finances out of Argentina’s dramatic and very painful episode), this litigation offers the chance of hammering the final wooden stake through the heart of a business model that is highly disruptive of international finances, particularly in the current circumstances.  In that case, the agonizing Argentine experience would be contributing twice to a more stable process for dealing with sovereign defaults.

*Fifth, in money terms, if you a) add the difference of what Elliot paid and what would be receiving under the Argentine proposal (as shown in the calculations in that document), and b) compute the capital appreciation post settlement due to a significant decline in country risk, the current holdouts would reap a significant return. Part of the esoteric discussion about the NPV of any debt restructuring is to define what the proper discount rate is. Argentina’s discount rate has been high because of this litigation, and it has gone even higher because of Judge Griesa’s misguided ruling that made the Bank of New York Mellon and the bondholders with performing debts hostages to the Elliot claim. If Elliot and company accept Argentina’s proposal, the discount rate for a post-settlement NPV calculation will be much lower, benefiting every one.  Elliot and company can continue to follow a strategy that hurts everyone, starting with New York as a financial center and future sovereign debt restructurings (but also including themselves, because they are bleeding legal and lobbying money, plus not getting their bonds paid back), or accept the reality that they will not get anything better than this offer and settle.

So we have a good equilibrium and a bad equilibrium.  In my opinion, Argentina does not have legal, political, or economic room to move from what it has offered. So the only coordinating devices to move to the good equilibrium are either a more realistic ruling by the US Court of Appeals for the Second Circuit in New York, or Elliot and company accepting the offer. The fact that the New York judges sent the proposal to the holdouts makes me think that they want a “good economic equilibrium,” but are struggling with the implications of the legal issues (“do we enforce the contracts as written to show that New York follows the ‘rule of law’ or this latter approach, by rewriting the contracts of other agents, may generate a more systemic damage to New York as a financial center”?).

For the holdouts all possible scenarios seem to imply more costs than accepting the offer. Their business model is already under threat by the Collective Action Clause, irrespective of this case. The possibility that Argentina accepts an adverse ruling and pays 100% or something better than what was offered in the previous debt exchanges, does not exist. Therefore, the only reason for the holdouts not to accept is to try to inflict further pain to Argentina, even though in the process they would not receive any payment, must continue paying legal and lobbying costs, and inflict serious damage to New York as a financial center and to innocent bystanders such the financial institutions involved in processing the payments and to the bondholders that accepted the previous debt exchanges. Even vulture funds should be able to use human cost-benefit analysis.

15 Responses to "Argentina and the Presentation to the Second Circuit US Court of Appeals"

  1. Tadej K   April 4, 2013 at 1:57 pm

    This is very likely the most biased commentary I've read on Economonitor for quite some months.

    And no, I am neither an Elliott lawyer, nor a holder of Argentine govt bonds. I just appreciate unbiased commentaries weighing pros and cons, seeing the aspects of both sides, and sadly this contribution lacks all of these. Fortunately, the author at least acknowledges that he held high offices for the Argentine govt, and patriotism and loyalty are held at high esteem in South America, particularly its de facto dictatorships.

    • Daniel   April 4, 2013 at 2:11 pm

      Realy

    • Eugenio Diaz-Bonilla
      Eugenio Diaz-Bonilla   April 4, 2013 at 8:01 pm

      Hi Tadej

      My comments are a simple cost/benefit analysis, as I understand the facts. Therefore, you should argue that my analysis is wrong, and provide a rationale for your own cost/benefit analysis. Bias, patriotism, and nationalism are concepts complete alien to those needed to prove me wrong, if you believe that such is the case. Best
      Eugenio Diaz-Bonilla

      • Tadej K   April 5, 2013 at 12:59 am

        Eugenio,
        You write that "you understand the facts", yet it is a fact that Judge Griesa understands the facts differently. Moreover, he *cannot* view this case from the perspective of a cost/benefit analysis, he must rule based on the applicable law and the terms in the prospectus of the bonds, disregarding the interests of Elliott, New York, or GOA completely.
        Furthermore, you write that "benefits for Argentina of ending the litigations in New York by re-routing payments may be more than the costs". I am not sure; South American governments had, and have, reasons for issuing bonds under US law. And many analysts say that GOA, with its mocking and obstinate attitude towards US courts which GOA itself authorized for settling such cases, is inflicting much unnecessary harm to Argentina and its future.
        Similarly, I am not sure it is a fact that "economic and financial agents in New York are already unhappy with the attitude of the holdouts and with Judge Griesa’s ruling". But again, it does not matter whether they are happy or sad, a judge's ruling must obey the law and that is it, and they must obey the judge's ruling.
        Best regards, Tadej

        • Eugenio Diaz-Bonilla
          Eugenio Diaz-Bonilla   April 5, 2013 at 10:39 am

          Hi Tadej

          Thank you very much for your comments. They allow me to clarify some of my points and have a reasoned conversation.
          1. I thought it was clear that my cost/benefit analysis was from the point of view of the Elliot fund and similar holdouts and the GOA, as I understand the facts. It is completely unrelated to Judge Griesa's ruling, who, obviously, must conduct a legal analysis (by the way, I said "as I understand the facts," and not that "I understand the facts"; there is a huge difference in those phrases, because the first one usually implies that I acknowledge the fact that I may not have understood de facts properly, which is the meaning I intended).
          2. Your second point is that Argentina is misreading the C/B analysis. I am not convinced: again, as I understand the facts, the GOA seems to believe that if it accepts to give the litigants a better deal, there will be an avalanche of lawsuits both, from those that accepted the previous exchanges, and from those who did not. The costs will be 40 or 50 times the amount in this lawsuit, more years of litigation, and not market access for an uncertain period. This without even mentioning the political costs.
          3.Your third point is that "a judge's ruling must obey the law". This is a crucial point in the dilemma the Second Court faces: Judge Griesa in order to enforce the written contract of the bonds held by Elliot (which would show that NY courts is a place where contracts are enforced) has unilaterally rewritten the contracts of other agents such as the Bank of New York Mellon and the bondholders who have performing bonds (which, if upheld, would massively undermine the claim that NY courts enforce the law and contracts as written). I interpret the actions of the Court (asking Argentina for a proposal, sending the proposal to the holdouts) as an indication that it understands the dilemma, and is trying to get to a solution without having to rule. Which leads me to my final point regarding Elliot fund and similar holdouts (the C/B analysis for small bondholders that bought the bonds before the default is different, and I am not addressing this issue here).
          4. My point is that if the "big" holdouts decide to reject the proposal (and now it is their move and no one else) they will be choosing a "bad equilibrium" in which all parties lose, including them. Now they are the only ones that can move the situation to the "good equilibrium" in which they make a not inconsiderable amount of money, stop bleeding legal and lobbying fees, claim victory, and move to some other pursuit.
          Best

  2. Andrew   April 4, 2013 at 7:53 pm

    Its fabulous to watch the 2nd Word unravel so.

  3. Andrew   April 4, 2013 at 7:53 pm

    Pay your bills.

  4. edsp   April 4, 2013 at 7:54 pm

    It makes sense. Elliott should accept this and do the right thing.
    Thanks for a good unbiased explanation.

  5. manuel rapoport   April 5, 2013 at 5:52 pm

    Just a few comments. In the final analysis, from a business point of view and not from a legal point of view, one has to decide whether to continue a fight or settle for something less but for something more than nothing. I am a firm believer that all debts must be paid. That is the law and that is what is morally correct. On the other hand, situations do arise that may make it impossible for a debtor to pay. In the private domain, we have bankrupsy. In the public domain we do not yet have something similar. A point that should be addressed in another fora. When a country is unable to pay its debts it must come to some agreement with its creditors, some agreements are just that , but others are a bit forced. This is the case in point here. A proposal to get something is better than getting nothing. If it makes business sense, then it should be taken.

  6. manuel rapoport   April 5, 2013 at 5:57 pm

    As a follow up. Look at the situation in Cyprus. Is it very different? There the Government applies a "tax" on large depositors in the banking system to make up their economic foes. A depositor is far from a large investor that runs the risk of the market by investing in the capital markets on such instruments as bonds. The investor knows the risks he is taking and may have to take a loss in the process, that's the name of the game. But it is alright for the Government to take the depositors money to make up their deficits. Is it legal? They say it is. It is morally correct. Probably not. Where do you draw the line? What hurts the financial well being of the markets, stealing from the common people, depositors, or from the investor?

  7. T Mullen   April 6, 2013 at 9:38 am

    Why aren't the current restructured bondholders offering to throw some money into the pot? Perhaps an exchange offer that reduces their principal slightly (these bonds trade as low as 50 cents on the $), conditioned on a minimum acceptance and a legal settlement by the Holdouts? This coupled with the GOA offering a New Money option could boost the NPV to the holdouts without GOA breaking their pledge to keep the offer in line with past offers.

  8. Nestor   April 9, 2013 at 6:40 am

    GOA does not need external financing?

    Of course not, it prints money at will and fuels inflation that currently stands at about 30% per year.

    Get out of here!

    • Alex   April 9, 2013 at 5:08 pm

      GOA doesn't print US$…

    • Alex   April 9, 2013 at 5:16 pm

      …and the Central Bank has over than 40 Billion of those
      I think that's why it can be say GOA does not need "URGENTLY" acces to credit markets