Argentina’s Impending Default: Fancy Footwork is a Bad Idea

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By Bianca Fernet, The Bubble

Well, it happened. The US Supreme Court ruled unequivocally 7-1 to uphold the Griesa ruling requiring Argentina to pay the so-called “Vulture Funds” the debt owed to them for holding not restructured bonds if they want to continue paying holders of restructured debt.

This is not good news for Argentina, especially in light of the positive steps Kicillof has taken over the past few months to reach an accord with Repsol over the expropriation of YPF, and to negotiate a payment plan with the Paris Club.

As Cristina demonstrated using cardboard signs and air quotes on a Cadena Nacional broadcast, Argentina is obligated to pay around US $1.3 billion to the litigating “vultures” by June 30, 2014. Worse still, as Kicillof himself admits, this would open the door to future litigation by other holdouts, which could obligate the nation to owe a sum to the order of US $15 billion.  As a point of reference, Argentina’s foreign reserves are currently sitting at US $29 billion.

In response, yesterday Standard & Poors cut its rating on Argentina two notches, from CCC+ to CCC- with a negative outlook.

The US court’s decision gives Argentina four options, none of which is particularly appealing.

  1. Pay the US $1.3 billion, jeopardize the ability to use reserves for other uses, and open the door to future holdout claims
  2. Default on the US $1.3 billion, and also default on the payments to the holders of restructured debt
  3. Try to change jurisdictions quickly in order to avoid paying the US $1.3 billion but continue paying the holders of the restructured debt
  4. Make emotional arguments and publicly reason with “vultures”, who actually have the decision-making capacity to grant a reprieve

Furthermore, the clock is ticking. Fast.  June 30 is a mere 12 days away.

Options 1 and 2 are very bad ideas. If Argentina makes payments to the holdouts, it will run out of money and have an economic crisis. If Argentina defaults, it will cut the country off from access to  international markets and funding an cause an economic crisis, but more importantly it will negate the positive strides made to date and deepen an already dangerous spiral of isolation that prevents individuals and companies from doing business and turning Argentina into what by all counts could be a thriving and prosperous nation

Argentina should opt for option 4. Unfortunately, it appears Kicillof and Kirchner are going for option 3.

Kiciloff reported yesterday that the government would pay holders of restructured debt under Argentine legislation, in Argentina. While this might make him feel better, it is a mistake.

Firstly, trying to pay restructured defaulted emerging market debt in the very emerging market in from which it emerged completely ignores the reason that Argentina issued both the original debt and organized the restructuring in US dollars in the United States in the first place. International and local investors don’t trust the peso and they don’t trust Argentina to issue debt locally. It is a cruel reality but it is indeed the way of the world.

Holders of restructured debt have already been quite flexible in taking a 70% haircut (agreeing to only receive 30% of what they were originally owed). If they are forced to endure another restructuring that would move these payments from US dollars into Argentine pesos and force potential claimants to enter the Argentine court system to get what they are owed, the “vultures” will be the least of Argentina’s economic woes. These vultures will be replaced by a pack of angry sparrows next time the peso is devalued or another restructuring is instituted. These bonds were issued in dollars in the United States to remove two significant risks of investing in emerging markets – currency and an unreliable judiciary.

Secondly, the teeth to the Griesa ruling were in the fact that it obligates financial intermediaries to comply with the ruling. The defaulted debt is in dollars, and even dollar payments handled by foreign banks are either routed through New York or are facilitated by international banks with significant US operations. While holders of the exchanged debt themselves would not be in violation for receiving funds, the bank delivering would be on very shaky and thin legal ice. Successful execution of Kicillof’s plan hinges on finding a bank willing to violate the US court’s order. Now he may be a beautiful man, but even those sideburns are not enough to convince a bank to go toe-to-toe with the US justice system.

Argentina’s case for not paying the holdouts has been largely emotional, but not untrue. Is Paul Singer a jerk? Probably. Do his hedge funds NML Capital and Aurelius Capital Management prey on weak defaulted debt and use legal expertise, patience, and deep pockets to sue for full value rather than negotiating a restructuring? Yes, and it is a fantastically-profitable business model, albeit an ethically questionable practice.

The problem with Argentina’s strategy is not that they do not have a good case, but that they have made their emotional case to one of the most globally respected legal bodies in the world. The US Supreme Court is not responsible for saying whether people are nice or mean, they are responsible for judging whether actions are permissible under current law. Put bluntly, it is neither their problem nor their job as Supreme Court justices to care if Argentina will default or its economy or people will suffer while hedge funds get richer. On a personal level I doubt Clarence Thomas and Antonin Scalia are laughing maniacally at Argentina’s unfortunate plight, but that doesn’t change the fact that under US law as interpreted Argentina faces one of two options: pay everyone or pay no one.

So that is why I argue for option 4 – invite the vultures to a public forum full of the internationally powerful organizations whose job it is to care that developing countries don’t descend into crippling poverty, and negotiate.

Cristina’s emotional outcry via the Cadena Nacional is persuasive, it just needs the right ears. But it also requires that both she, Kicillof, and the rest of the Argentine government eat a big slice of humble pie (a few humble empanadas?), drop the bombastic language, and face reality. Stop calling them vultures, stop claiming extortion, and stop pretending that negotiating with these holdouts is morally on the same level as Barack Obama having a coffee with Osama Bin Laden.

Argentina has an impressively strong emotional case for leniency from making full payment on these defaulted bonds. It just doesn’t have a legal case.

Mr. Kicillof should realize he is not in the World Cup, and the time for fancy footwork has ended. Argentina has taken hugely positive steps under his direction to reach an accord with Repsol and with the Paris Club, and he should capitalize on that momentum and force these “vultures” out of their legal comfort zone and into the eyes of the world where international pressure will be able to do what the US Supreme Court would not and should not do – they will cry for you, Argentina. By Bianca Fernet, The Bubble.

Also by Bianca Fernet: Argentina made a deal with the Paris Club of creditors on US$9.7 billion of arrears from the 2001 financial crisis. Economy minister Kicillof emerged, in his mind and that of many, victorious. Brilliant diplomatic showmanship. Read…. Argentina and the “Paris Club”

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