Playing Argentinian roulette - Debt troubles may shake global financial architecture

Martin Henry, Contributor

Yesterday, December 15, was to have been the final day for Argentina to pay more than US$1.3 billion to 'vulture funds'.  Thomas Griesa, 81, a United States (US) federal judge for the state of New York, who had made several previous rulings on the matter, in a November 21 ruling had ordered the country to pay immediately and in full everything it owes to the plaintiff funds.

A defiant Argentine government had vowed not to bow. President Christina Fernandez de Kirchner had declared that her administration would not pay a single dollar. A fiery young economy minister, Hernan Lorenzino, responded to the ruling by vowing to battle "judicial colonialism". Paying the vultures is not only unfair, but illegal, following our own internal rules", Lorenzino told media reporters, referring to Argentina's ley cerrojo, or lock law, passed by the Congress after the historic 2001 debt default and which bans the reopening of debt restructuring.

"We'll fight all decisions that are against the interest of our country," the minister declared. Stating his belief that the US justice system can and will fix this in a way that won't affect Argentina and its legitimate creditors, Minister Lorenzino then played the trump card which every indebted country in the world holds in its hands: in an international context where the importance of these decisions is patently clear, the United States justice system is expected (no, demanded) to act in a manner which will preserve the international financial architecture.

In other words, the US justice system mustn't do anything stupid that would further batter the global financial architecture in a recessionary world, as Superstorm Sandy did to physical architecture in the US Northeast and the Caribbean only a month before Judge Griesa's ruling.

Despite expressions of
concern from the Federal Reserve, Judge Griesa was unbowed. "It
is hardly an injustice," he argued, "to have legal
rulings which, at long last, mean that Argentina must pay the debts
which it owes. After 10 years of litigation, this is a just
result." And, responding to the Argentine stance, the judge
wrote, "These threats of defiance cannot go by unheeded. The
less time Argentina is given to devise means of evasion, the more
assurance there is against such
evasion."

That's the law, pure and simple,
as far as Judge Griesa is concerned.

When Venezuela
defaulted on its sovereign debt in 1902, The Economist
reminded us in 2005 at the time when Argentina was
"restructuring its debt", British, German and Italian gunboats blockaded
the country's ports until the government paid up. And further back, in
1881, when the Ottoman Empire reneged on its debt obligations, European
powers seized Ottoman customs houses and paid themselves their due. The
options available to more than 500,000 creditors to Argentina,
The Economist said then, were more
limited.

Judge Griesa has ruled that if Argentina does
not settle, the Bank of New York, which handles Argentina's bond
payments and is conveniently based in United States territory, will be
obliged to stop payments to other bond holders or be in violation of the
law.

The nervous global financial markets see the
matter through very different spectacles. The US Federal Reserve and the
Clearing House, a trade group representing the world's largest
commercial banks, said an Associated Press story carried by The
Sunday Gleaner, advised the judge to make sure his order
would not affect the US funds-transfer system, which automatically moves
an average of US$2.6 trillion a day in half-million transfers between
more than 7,000 banks.

The entire system depends on
transfers being "immediate, final and irrevocable" when processed.
Requiring intermediaries to identify, stop and divert payments according
to court orders "would impede the use of rapid electronic funds
transfers in commerce by causing delays and driving up costs," they
argued.

REMEDY DOESN'T HELP

The
Griesa remedy also sent jitters through the legal departments of the
most powerful financial institutions in the United States, the AP story
said.

"It's a mess. This does not help
Argentina. Default could happen," a Goldman Sachs analyst
Alberto Ramos in New York said last Thursday. "The markets will
react [and have reacted] negatively to
this."

Judge Griesa calmly dismissed these
concerns, arguing that "if Argentina complies with the rulings of the
court, there will be no problem".

A stay of execution
has been granted by an appeals court which has overruled the Griesa
judgment, setting a February 27, 2013, date for fresh hearings. If
Argentina had failed to pay under the Griesa ruling, the country would
have technically been declared bankrupt, a state of affairs with which
member of parliament for NE St Ann, Shahine Robinson, can painfully
identify at the personal level. The court has ordered her to pay costs
of $15,373,547.47, plus interest, incurred by complainant Manley Bowen
in a case brought against her over her dual citizenship as an MP, or be
declared bankrupt.

In 2001, in the face of a collapsed
economy caused, in large part, by the debt burden, Argentina stopped
paying its debts, going into a world record US$95-billion
default.

The government later offered new bonds to its
creditors valued at less than 30 cents for each dollar owed. By 2010,
some 93 per cent of the original bondholders had agreed to the
"haircut". Jamaica has gone this route with a partial debt-restructuring
exercise, the Jamaica Debt Exchange (JDX), with the major difference
that the debt 'restructured' was the domestic debt, not the foreign
component like Argentina. The JDX, quietly accepted by 100 per cent of
bondholders, has been widely praised as a success and a
model.

That 2005 Economist story
referred to earlier was titled 'Argentina's debt restructuring: A
victory by default?' The subhead declared: "The successful restructuring
of Argentina's debts has set a painful new benchmark for
creditors."

The AP story on November 25 said, "The
debt relief granted by these 'exchange bondholders' enabled Argentina to
climb out of a deep economic crisis, and many analysts have described
it as a model for Greece and other debt-burdened countries to
consider."

At the height of the Greek debt debacle
last year, the UK's Guardian newspaper ran the story,
'Defaulting rescued Argentina. It could work for Athens too'.
"Struggling under an impossible burden after its IMF
(International Monetary Fund) bailouts, Buenos Aires knew its one hope
was to stop paying its debts and become a pariah - and so it
proved," the paper said (July 10, 2011).

A
commentator for Businessweek, Drew Benson, stated as
the "bottom line" in his March 15 column, 'Sovereign Debt: What Greece
can learn from Argentina's default': "Defaulting on $95 billion
in bonds hurt Argentina's credit rating but not its economy, which has
grown about seven per cent a year since
2005."

'VULTURE FUNDS'

The
fly in the ointment are the so-called 'vulture funds'. Even in a
default, The Economist pointed out, there is money to
be made. So-called 'vulture' funds pick over the non-performing bonds
discarded by disheartened investors. In the summer of 2002, a few months
after Argentina stopped honouring its debts, a brave buyer could have
purchased a distressed bond in the secondary market for 20 cents on the
dollar or less. A few months later, that buyer could have swapped it for
paper worth 35-37 cents: an annualised return of 25 per cent or
more.

Not every vulture will settle for such quick
pickings, the news magazine noted. The more patient among them will hold
out for their full pound of flesh through the courts. Holdouts led by
NML Capital Ltd, an investment fund owned by US billionaire Paul Singer,
refused the swaps, and have been insisting on payment in full, plus
interest. Judge Griesa had ordered that the holdouts be paid 100 per
cent plus interest for the debt that had been bought for pennies on the
dollar in 2002, when Argentina's economy was in
ruins.

Annualised returns from successful litigation,
according to Manmohan Singh, an economist at the IMF, The
Economist reported, can be more than 300 per cent. And,
paradoxically, the higher the acceptance rate for a debt deal [93 per
cent for the Argentine deal], the better for the refusniks, since
governments are more likely to settle with a small minority than with a
large number of litigants.

Argentina's debt-to-GDP
ratio stood at 165 per cent at default; Jamaica's now dangerously stands
at around 140 per cent, even with JDX. The Griesa ruling raises some
critical challenges for the whole world. By law and convention,
sovereign debt must be paid no, matter who accumulated it under what
conditions and what damage may be done to the debtor
country.

Argentina descended into both economic and
social chaos before default. But the debt burdens of many countries have
risen to intolerable levels. Paying imposes not only unbearable burdens
on these countries but poses substantial risks to the global economy as
these sovereign economies threaten to implode like Greece, dragging the
system down with them.

Not paying not only denies
creditors their legitimate due but poses its own risks to the global
financial architecture held together by the expectation that debts will
be honoured. That February 27 hearing on the Argentine case by a US
court of appeal is of global significance, and to no country more than
ours with its J$1.7-trillion debt which everybody knows we can pay on,
but never pay off.

FOOTNOTE: One of
the few things I have done longer than writing this column for 25 years
is being married to Jacqueline. Today is our 28th anniversary. In the
early pre-electronic days, Jacqui made a significant contribution to the
production of the column by transcribing my handwriting, which the
editor said was illegible, into beautiful script. Happy anniversary,
beloved.

Martin Henry is a communication specialist.
Email feedback to columns@gleanerjm.com and
medhen@gmail.com.