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In April, less than five months after coming into office, president Mauricio Macri of Argentina ended the 15-year history of rancorous dispute that followed the country’s default in December 2001. The new government’s willingness to make a genuine effort to secure a settlement won him the blessing of the US courts and then secured a settlement acceptable to most of the holdout creditors. With a settlement in sight, the Macri government was able to borrow $16.5bn in April, at a modest interest rate, for a serial defaulter, of 7.5 per cent. So it was able to pay off the creditors, at last.
Is this a happy ending? The answer has to be: only up to a point.
From the Argentine point of view, the advantages of settling the dispute would seem overwhelming. The country is no longer a financial pariah. It has access to capital markets and this, in turn, gives the government new opportunities. Even so, it faces dangers. One is that the temptation to borrow too much will again prove overwhelming, particularly for the government of a politically divided country with a long history of irresponsible policies. Another is that Argentina might become too attractive to capital, both foreign and domestically owned, and so suffer an economically damaging appreciation of the exchange rate.
From the vantage point of the creditors, the benefits of the deal would also seem considerable, at first glance. The funds due to holders of the bonds offered by the Argentine government in 2005 and 2010, in exchange for the defaulted bonds, are no longer held hostage to the dispute between the holdout creditors and Argentina. Those who accepted a deal early on will now receive the interest and principal they are due.
Holders of holdout bonds seem to have done well, too: after a long struggle, the strategy of endless litigation seems to have worked. But, it appears, holders of so-called “Floating Rate Accrual Notes due 2005”, which offered extraordinarily favourable terms with respect to the interest rates, have done best. Other holdouts have not done so strikingly well relative to those who accepted the exchange in 2005.
The big concerns arise, however, over the effects of the deal on the management of sovereign defaults, more broadly. Such defaults are inevitable. Indeed, the fact that yields on sovereign bonds vary widely shows investors believe some bonds are substantially riskier than others. Defaults become a big problem, however, if, as happened in the case of Argentina, they lead to a 15-year struggle between the debtor and creditors.
Just as bankruptcy procedures replaced prison for debtors in the 19th century, so more expeditious and effective ways need to be found to resolve sovereign bankruptcies.
The International Monetary Fund argued persuasively for such a formal procedure — a “sovereign debt restructuring mechanism” — in 2002. It was unable to obtain support from important countries, notably the US, for an idea that would have delivered binding international oversight over sovereign defaults. Instead, agreement was reached on the insertion of collective action clauses into bond contracts, as a way of encouraging settlements.
The Argentine experience again underlines the need for such collective action clauses. But those clauses must allow aggregation across debt instruments, in order to prevent creditors from obtaining blocking positions in particular instruments relatively cheaply.
A further point that is now widely understood is that, in new contracts, the “pari passu” clause must be clarified. As interpreted by US courts in the Argentine case, this apparently innocuous phrase allowed holdouts to obtain an injunction that prevented payments to those who had accepted exchange bonds if payments were not also made to the holdouts. This clause should, in future, rule out an equal obligation to service debt owed to those who have accepted a debt restructuring and those who have not.
Such changes would appear to remove the most disturbing features of the Argentine case. Yet, in the absence of a global sovereign bankruptcy procedure, such changes will only apply in future. This creates a big transitional problem, since huge quantities of outstanding debt have been issued with defective clauses.
Given the success of the holdout strategy in the Argentine case — ultimately, these creditors forced Argentina to settle on fairly favourable terms — the incentive to pursue this strategy in future must be strong. Moreover, since it was the agreement of those who accepted less in the past that allowed the holdouts to be paid off, the willingness of all creditors to accept terms in a negotiation will now be weaker.
An important question is whether US courts will act in the same way as they did in the case of Argentina, even if debtors behave more reasonably than Buenos Aires, which was egregiously uncooperative under previous governments.
Given the incentives for holding out and this legal uncertainty, one can reasonably fear the emergence of similarly difficult cases in future.
Yes, we can hope the Argentine case will prove a depressing exception, not a precedent. Unfortunately, that might prove rather too optimistic.
Martin Wolf is the FT’s chief economics commentator
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