Body
Argentina and the small group of creditors demanding full payment from the nation's 2001 default failed to resolve their differences on July 30. As a result, creditors did not receive the $539 million interest payment on Argentina's restructured bonds that had to be paid by that date. The default happened because US courts ruled that Argentina cannot pay over 92 percent of its bondholders who agreed to reduce their claims by as much as two-thirds—unless it pays the holdouts in full—and Argentina was not willing to pay the holdouts in full.
By most definitions, this puts the country in default on about $29 billion in foreign debt. Standard & Poors downgraded Argentina's debt to "selective default" the same evening. Midday Friday, a committee of the International Swaps and Derivatives Association decided that there had been a "failure to pay," triggering protection contracts against Argentina's default—$1 billion could change hands.
Argentina has continued to insist that it did not default, and rumors swirled about banks in Argentina paying the holdout creditors themselves to help the government. Nobel Laureate Joseph Stiglitz described the case as "America throwing a bomb into the global economic system," and 100 prominent economists from around the world signed a letter to the US Congress asking it to fix the mess left by the courts. Meanwhile schemes for getting rich off default filled the market grapevine. Everyone seems to agree on one thing: This is complex. To help navigate post-default complexity, here is a brief guide.
Did Argentina default?
Argentina's restructured debt contracts [PDF] say: "[T]he Republic's obligation to make payments of principal of and interest on the Securities shall not have been satisfied until such payments are received by the Holders of the Securities." The holders did not get the money 30 days after it was due. This is an "event of default" under the contracts. Therefore, it sure looks like Argentina is in default.
US federal district Judge Thomas P. Griesa, who has presided over the case for over a decade, was visibly frustrated at a hearing on Friday, August 1, with Argentina's continued insistence that it has paid and remains willing to pay its debts. For their part, Argentina's lawyers complained that the special master appointed by the judge to help the parties negotiate made public statements suggesting there had been a default. This seems to be a new bone of contention in a case that already has more than it can handle.
How can Argentina say that it did not default?
Argentina argues that because it sent the money to Bank of New York Mellon, the trustee for the restructured bondholders, it has done its part. The fact that the bondholders down the payment chain did not get the money is not Argentina's fault, since it was a US court order that prevented the bank from sending the money onward.
This is factually correct and very bizarre. But it still does not change the fact that the bondholders did not get their money. This is the first time in memory that a country goes into a massive debt default pursuant to a court order.
How could a court allow a tiny minority of creditors drive a country into default?
Default was not the plan. US courts have spent many years hearing lawsuits from Argentina's 2001 debt default. The judge in this case has ruled many times that Argentina owes creditors the full amount in their contracts, but has been utterly unable to make it pay. Early in the case other judges and he even ruled in favor of Argentina several times, protecting its property from seizure by creditors despite the fact that it left the court's judgments unsatisfied.
Perhaps out of exasperation, two years ago the judge resorted to an extreme measure: blocking payments on $29 billion in the hope that Argentina would pay $1.5 billion, and threatening banks and payment systems around the world with contempt if they tried to help Argentina pay the holders of restructured bonds. Appeals courts backed him up, and the Supreme Court refused to review the case on June 16.
On July 30 the strategy apparently misfired. Argentine officials simply had no political capacity to pay the holdouts the 100 percent payout that they demanded, or even to buy time. The political cost of a massive default turned out to be smaller—for now—than the cost of settlement.
This has been a hard way to learn the lesson that US courts ultimately have no control over the domestic politics of foreign countries.
What happens next?
In default, 25 percent of holders of any series of restructured bonds that did not get paid can vote to "accelerate," or demand full principal and unpaid interest on their bonds. "Series" are batches of identical securities (for example, paid in the same place, in the same currency, and governed by the law of the same jurisdiction). Among the newly defaulted bonds, there are those paid in New York, Belgium, Luxembourg, and Tokyo, denominated in dollars, euros, and yen, governed by New York and English law.
Default can be "cured" if payment is made. Then 50 percent of holders of a series can vote to rescind the acceleration.
Argentina's other bondholders—who have yet to miss a payment—also have the right to accelerate with a 25 percent vote, simply because the July 30 group did not get paid. This is called a "cross-default." However, if Argentina makes up the July 30 payment within 60 days, the cross-default automatically goes away; no vote necessary.
Will anyone accelerate?
It is hard to tell. Many people are threatening to do it. But once you accelerate, you lose a measure of control because everyone else could be tempted to accelerate, just to make sure they are not left out of an eventual settlement. And if everyone accelerates, it is hard to imagine how anyone gets paid. Argentina simply faces a much bigger mountain of claims from different groups of creditors with different motivations and strategies. A bigger and nastier stalemate is the likely outcome.
To be sure, there are people who might be betting on a complete collapse of Argentina's house of debt, and could get 25 percent of their colleagues to go along. To make an intelligent prediction, it is important to know who holds the debt and what their game plan might be. Because it is easier to buy a blocking position in a small series, it pays to watch the small series closely.
Will there be lawsuits?
If there is no acceleration, lawsuits are unlikely because it is not worth the creditors' time to sue over a $539 million interest payment. Once there is acceleration and billions of dollars in debt is in play, there is an additional barrier to lawsuits.In general, only the trustee can sue Argentina, and creditors would have to get 25 percent of a series to instruct the trustee to sue. They would also have to indemnify the trustee in connection with the lawsuit. Given the messy history of this case, this would not be a trivial indemnity.
Do the holdouts benefit from default or acceleration?
Not directly. Until Wednesday, they had a relatively clear shot at their target, Argentina. Soon they might be joined by $29 billion in angry creditors, all going after the same dwindling pot of money that has eluded even the most determined holdouts for over a decade.
Unless Argentina's economy starts to deteriorate rapidly as a result of the default, crossing the default bridge might reduce the political pressure on the government to settle with the plaintiffs in this case.Finally, having more defaulted debt makes the eventual settlement much more complicated to craft, especially as default drags on. Different creditor groups with different preferences and constraints would be pulling in different directions, as the middle ground vanishes.
Who must be part of the settlement?
First, the holdout creditors who sued in this case. They claim about $1.5 billion in this lawsuit alone, based on defaulted bonds with the face value of less than $500 million. Most of the money represents past due interest. These same creditors claim another $2.5 billion, which is not part of this lawsuit, but would likely have the right to the same relief.
Second, other holdout creditors, who are not represented in this case, but who also hold bonds from the 2001 default—approximately another $11 billion. They are also likely to have the same rights as the first group. In theory, if the first group settles with Argentina by itself, the second group can simply repeat the lawsuit brought by the first group—free-riding the free riders.
This is why Argentina insists that any settlement must be able to cover both groups.
Third, as of July 30, the holders of defaulted restructured bonds denominated in foreign currencies and governed by US and English law. They seem to be a mixed bunch, with some creditors repeatedly pleading with the court to let the payment go, and others reportedly lying in wait to accelerate and sue.
Even if Argentina were able to restore payments to this third group quickly, it faces another threat. Restructured bond contracts from 2005 and 2010 promise the new creditors the benefit of any future offer that Argentina might make to the holdout creditors. Some restructured bondholders have made noises about suing on this "rights upon future offers" (or RUFO) clause if Argentina settles the lawsuit with the holdouts. This could result in liability for Argentina upward of $100 billion; some estimates reach $500 billion. The RUFO clause expires at the end of 2014.
Is RUFO a real constraint for Argentina?
There are excellent arguments that a properly structured settlement with the holdouts should not trigger RUFO. Paradoxically, this does not matter because the clause has never been interpreted by a New York court, and there is no way to get absolute certainty on the interpretation in the next few months.
Regardless of its legal merits, the clause has become a real political constraint for Argentine decision makers, because they are facing RUFO lawsuits abroad and personal lawsuits in Argentina for exposing the state to RUFO liability.
The relatively modest impact of default so far supports their calculus: Certain default with limited consequences is preferable to potentially enormous liability for the state and the politicians under RUFO, even if the chances of being found liable are small.
Can anything else go wrong?
Plenty. For example, restructured bonds denominated in dollars and governed by Argentine law got a reprieve from the injunction just a few days before the default, but the judge said that he was granting the reprieve just this once, as an exception.
If the judge blocks payment on these bonds down the line, it could affect anywhere between $8 billion and over $29 billion in debt, because the Argentine law restructured bonds are mixed up with and indistinguishable from new bonds that are unrelated to the 2001 debt default, including bonds issued just months ago to settle the investment dispute with oil company Repsol. The judge instructed Argentina and Citibank's branch in Buenos Aires, which is supposed to process payments on these bonds as custodian, to figure out how to separate the various bonds, but it is not clear that it can be done.
Can Argentine banks ride to the rescue of their government?
For the past few weeks, there have been reports that Argentine banks are offering to put up money to help the government. They could deposit money with the court in exchange for the holdout plaintiffs' agreement to a stay, allowing payment on the bonds due in July, possibly even September, to help the negotiation along. Some have also suggested that the banks could buy up the holdout debt and make the lawsuit go away.
Anything is possible, but any such scheme would be hard to execute. First, if the plaintiff holdouts do not trust Argentina, it is not clear why a $300 million deposit from the banks would give them comfort in Argentina's capacity and willingness to pay a lot more than that even after RUFO expires. Buying the holdout debt could be similarly expensive. More important, unless the banks buy the full $15 billion or so in holdout debt from 2001, they could find themselves paying a lot of money simply to buy time until the next lawsuit by the remaining holdouts, which could be the day after the settlement is announced.
What will it take to resolve all this?
Trust. After years of digging in their heels, none of the players appear to have room for maneuver of the sort it would take to reach a deal, any deal. Not the holdouts, not the judge, and certainly not Argentina. It would be appalling to see this mess drag on, inevitably dragging more and more innocent people into the hopeless battle that has done nothing but damage to the combatants and the international financial system.
Whose fault is it?
The missed payment has revived a frenzy of finger-pointing at Argentina, the holdout creditors, and the presiding judge. There is plenty of blame to go around. But one can also argue that everyone involved is playing a part in a deeply dysfunctional system. Argentina's government is operating under its own set of political constraints that make default preferable to settlement. I am not sure we are in a position to judge those after the US debt ceiling adventures [PDF]. Yet the holdouts' business model is all about getting more money than the vast majority of creditors. This business model can exist only because there is no bankruptcy for countries to block such free-riding. Without bankruptcy, no one can take away their contract rights.
Finally, the judge's job is to enforce contracts, not micromanage bond payment details. Typically this involves putting enough pressure on debtors and creditors so they either do as they promised, or negotiate a settlement. By law, judges have an enormous amount of discretion in how they achieve this result, and this judge's decisions have been upheld multiple times on appeal. It is also quite common to tell the parties to go figure out the mechanics of compliance on their own.
The problem in this case is not that the judge does not know enough about Argentina's payment mechanics, as so many news outlets have suggested, but rather that his orders require him to know too much. He simply cannot change Argentina's domestic politics. Therefore he has tried to cut off some, but not all, of the country's ties with the global financial system, and has threatened bits and pieces of this system with contempt of court. Such picking and choosing requires more knowledge and micromanagement than most courts can muster. Even then the resolution of the crisis is up to the people of Argentina and their elected leaders, who remain beyond the power of even the most sophisticated court.
