Argentina appears willing to negotiate its way out of a bitter, long-running dispute with bond investors, now that it has run out of legal options to avoid paying them off.
That would be the smart move, because the alternative to a negotiated settlement would be a fresh debt crisis – and an almost certain default – for the beleaguered government. Argentina, which already ranks among the world leaders when it comes to sovereign deadbeats, could say goodbye to its efforts to regain access to capital markets.
The government exhausted its last legal challenge this week when the U.S. Supreme Court refused to review lower-court rulings requiring full payment of about $1.3-billion (U.S.) owed to a small number of sophisticated creditors in the wake of the country's last default in late 2001.
After the insolvent government defaulted on nearly $100-billion worth of bonds, it offered an exchange of new debt as part of a restructuring in 2005 that lopped about 70 per cent off the value of the old bonds. That was followed by a similar hard-nosed proposal five years later. Bond owners accounting for about 93 per cent of the debt outstanding accepted the deal on the grounds that a bad deal was better than none at all.
The remaining bonds have fallen into the hands of holdouts who rejected the terms. These are deep-pocketed hedge funds and other opportunistic investors, popularly known as vultures, who snapped up the defaulted debt for a fraction of its face value and demanded repayment of the entire amount. They are entitled to do so under the conditions of the original bond issue and they haven't budged from that position.
S&P slashed the country's already low credit rating immediately after President Cristina Fernandez vowed to ignore the court order, which requires Argentina to pay off the holdouts if it is also meeting interest payments to holders of the restructured bonds. Argentina, which is already dipping into dwindling central bank reserves to cover its debt obligations, says it cannot do both.
Courts have typically steered clear of these messy government debt restructurings, because unlike corporate failures, there is no means of overseeing them to assure that creditors get fair and equal treatment. And it's tough to enforce judgments. Seizing the occasional jet, freighter or foreign real estate holding makes other governments nervous and it doesn't bring much of a return.
So most situations end up resolved through negotiations, where both sides reach a deal that involves living with some sort of haircut, often in exchange for new bonds with lower interest rates or longer maturities.
Holdouts have sued in the past and often won judgments that were all but unenforceable. But the Argentine case takes this kind of dispute to a whole new level.
The government could have avoided the setback by offering more in the restructurings. It also could have attached a collective action clause to the original bond issue, which would have tied the U.S. court's hands. Such clauses force all bondholders to accept the terms of a restructuring if an overwhelming majority agrees. Greece went even further at the height of its financial crisis, applying such a clause retroactively to force bank creditors to take steep losses.
Critics warn that the U.S. ruling sets a precedent that will make it tougher for other embattled governments to restructure debts in future, because there would be less incentive for creditors to accept unfavourable terms. But a more positive story could come out of all this: Policy makers will have a greater incentive to exercise stronger discipline in managing their countries' economic and fiscal affairs and won't be as eager to rely on borrowed money to live beyond their means.