Anger and denial were the first emotions that registered from Argentine president Cristina Fernández de Kirchner on June 17 when the United States Supreme Court rejected intervention in the ongoing legal battle between the country and the group of bondholders to whom Argentina owes $1.33 billion from bonds that it defaulted on during the country’s economic crisis of 2001.
The position of Fernández de Kirchner was spelled out in a recorded message in which she said, “You have to distinguish between negotiation and extortion.” The Argentine president let it be known that she was not going to accept the judgment of the Supreme Court, which left standing the court order of Federal Judge Thomas Griesa, who had mandated that Argentina must make payments to the 7% of the nation’s creditors who had not entered into the debt swap arrangements made available to them in 2005 and 2010. These bondholders included investment funds Aurelius Capital Management and NML Capital, and a group of 13 others, whose aggregate claims amounted to $1.33 billion plus interest.
However, the government then took a subsequent step in the opposite direction. Ultimately, the president and her team of advisors decided at the last minute to negotiate in order to end what has become a dangerous situation for Argentina. The country’s failure to accept the judgment could mean entering into default once again, thus rendering useless the payments that Argentina had agreed to pay the other 93% of its creditors, and sending the country into bankruptcy.
This change of strategy was captured later in an advertisement taken out by the government of Argentina in The Wall Street Journal, in which officials confirmed the country’s willingness to “continue paying its debts” and claimed that the U.S. federal judge “promotes conditions for negotiating a resolution” of the dispute with the plaintiff bondholders. During a public meeting held on June 20, Argentina’s Flag Day, Fernandez Kirchner said, “We want to comply with 100% of the creditors.”
Subsequently, after Griesa blocked Argentina from making $539 million in interest payments due on some of its bonds, Argentina announced that it would send a delegation to meet with a court-appointed lawyer on July 7. Observers believe that Argentina will likely default if it cannot get that money to bondholders before a 30-day grace period. The judge has ruled that Argentina must pay the hedge funds that are suing to collect on their defaulted bonds at the same time it pays those investors who own bonds the country issued after its 2001 default.
The Argentine government must learn that it “has to play cleanly, both with respect to its citizens and the international community.” –Mauro Guillen
According to Wharton management professor Mauro Guillen, the government must learn that it “has to play cleanly, both with respect to its citizens and the international community.” Over the short term, the new, cooperative attitude of the Argentine government had a positive reaction in the marketplace, where bond prices rose by 9% in Buenos Aires, and by between 13% to 18% on dollar-denominated bonds and coupons linked to Argentina’s gross domestic product (GDP). That derivative investment takes into account the growth rate of the Argentine GDP, as well as changes in the real exchange rate and the volatility of the growth rate of GDP in 30 years. In addition, the government began to lower the value of the “blue dollar” (the dollar exchange rate on the black or parallel market), by raising its value against the peso, from 12.45 pesos per dollar to 11.90 pesos per dollar.
A Long History
Argentina’s current predicament began when then-President Nestor Kirchner assumed the job in 2004, during the aftermath of the social and economic crisis that battered the country at the end of 2001. To provide a solution to the $102 billion debt that the country maintained with its domestic and foreign creditors, the government opened two debt exchanges in 2005 and 2010, through which it managed to get support from 93% of the investors by providing them with a settlement at a 65% discount on the dollar.
The other 7% of bondholders did not accept this settlement process, and continued their legal action in the United States, where the bonds had jurisdiction. Among them were two investment funds that buy low-priced bonds — otherwise known as “junk bonds.” The two so-called “vulture funds” — Aurelius and NML — had paid $48 million to acquire Argentine bonds, whose market prices had collapsed because they were considered highly risky. In the wake of the legal judgment in the U.S., these funders were due to receive a stunning $900 million dollars — that is to say, 100% of the bonds’ face value, plus interest. In denouncing the latest judgment against Argentina, President Fernandez de Kirchner said, “I believe that in all of organized crime, there has never been a case of a profit of 1,608% in such a short time.”
The country’s debt problems don’t stop there: An additional $15 billion dollars from other creditors remains in limbo, and thanks to the decision of Judge Griesa, these bondholders now have a legal precedent to validate their claims.
Meanwhile, the government of Fernández de Kirchner has tried to relieve itself of two other important debt burdens — its debt to Repsol, the Spanish oil company, and to the Club of Paris, an informal forum of official creditors and debtor nations. At the end of April, Argentina agreed to pay Repsol $5 billion in bonds for the 51% of Repsol’s shares that the government had expropriated. Moreover, on May 28, the Argentine government agreed to pay the Club of Paris the sum of $10 billion over five years, with an initial capital payment of $650 million.
“This is the government that, some years ago, illegally seized the reserves of its Central Bank, and then the funds of private pensions, robbing all Argentines of their savings,” says Guillen. “It also robbed the shareholders of Repsol. I believe that in this case, it is quite right if investors can exert pressure on [the government]. And it would be even better if the markets closed again [to Argentina], and if Argentina wound up suspending its payments again.”
The Argentine government is set to begin negotiations, or the establishment of conditions for talks, with the holdout creditors on July 7, with government officials scheduled to meet with the mediator assigned by Judge Griesa, the country’s Economy Ministry said on June 30.
“Unfortunately, the decisions of this government with respect to how to deal with the non-payment of its debt will wind up having a negative impact on the quality of life of the Argentine people, not on the people who rule the country.” –Alejandro Corbacho
“Judge Griesa said … that if [the government] wants to negotiate, a path that upholds the status quo has to be proposed so that there is no default,” the release stated, adding that “Argentina thus reiterates its commitment to negotiating under just, egalitarian and legal conditions that contemplate 100% of creditors … allowing restructured creditors to be paid.”
According to economist Fausto Spotorno, director of Orlando J. Ferreres, a Buenos Aires-based consultancy, Argentina does not have a lot of options from here on. “Basically, it is about paying the judgment or going into default. Knowing that the default could be very harmful, at this stage, they have to cut their losses,” Spotorno says. “To do that, their strategy would be to try to pay without using their reserves, or to use some sort of debt but not in a way that can be understood as a violation of the [Right Upon Future Offers] clause” in their contract with creditors. This clause guarantees those who participated in previous debt exchanges that if Argentina makes a new voluntary offer to holdouts, it must be offered to all of them. The clause provides the court and the holdouts a legal and financial engineering mechanism that enables Argentina to pay without producing a new wave of lawsuits.
Currently, the reserves of Argentina’s Central Bank amount to barely $28 billion, which means that paying in cash would leave the country without any financial foundations. In the view of Alejandro Corbacho, director of the political science and international relations department at the University of UCEMA in Buenos Aires, the Argentine government “will try to pay the bonds in a package for those who have renegotiated. Nevertheless, given the obstacle represented by this judicial decision in favor of the bondholders, [the government] will request an extension of the maturity dates [of the bonds] so it can facilitate payments and negotiate … its payments to bondholders in the future, spreading those payments over as long a time-frame as possible.”
The recent agreements with Repsol and the Club of Paris can serve as a good precedent. “I believe that this is the best approach to pursue,” notes Spotorno. “Nevertheless, it is possible that in this case, the financial engineering [involved in such an approach] could be more complex.” Spotorno warns of the possibility that the government will issue new bonds with new maturity dates.
A Matter of Principle
While the government of Argentina resolves its debt problems in the United States, other factors are having an impact on Argentina’s economy. “Unfortunately, the decisions of this government with respect to how to deal with the non-payment of its debt will wind up having a negative impact on the quality of life of the Argentine people, not on the people who rule the country,” Corbacho says.
Both Corbacho and Spotorno agree that in the short term, Argentine firms will be frozen out of international financing, not only for investments involving foreign trade but also for financing of domestic projects. “Nevertheless, to resolve this positively, it is possible that all of this [economic activity] will recover” even if it means that the interest rates on government bonds decline, Spotorno notes.
“In 2001, when Argentina entered into default, a consensus emerged that it was better if economies [with serious debt problems] entered into default rather than have international organizations finance these countries’ debts.” –Fausto Spotorno
According to Corbacho, “It will wind up being difficult and costly for this country to get loans from abroad. History cannot be changed in the brief time still left for [Kirchner's] administration [which ends in December 2015]. To achieve that goal, [Argentina's leaders] need to accept conditions that do not match up with their rhetoric. This has a greater chance of happening after there is a new government, and there is a change in expectations.”
Argentina’s situation is not unique. Other emerging economies have restructured their debts, including Greece in 2011. And the events that just transpired in the United States with respect to Argentina’s debt can set a precedent for other situations in the future, experts say. Both the member states of Mercosur (Argentina, Brazil, Paraguay Uruguay and Venezuela), and of the Community of Latin American and Caribbean States, a regional community established in 2010, have expressed their support for the Kirchner government’s position regarding recent court decisions and the maneuvers of the U.S. funds. The heads of state of the Mercosur nations have jointly expressed “their most absolute rejection of the attitude” of the holdouts, and denounced the holdouts’ behavior for “blocking the completion of definitive agreements between debtors and creditors, and for putting the financial stability of various countries at risk.”
Guillen notes that there must be a distinction between the case of Argentina, and the basic principle for resolving these situations, irrespective of the countries involved. “The general principle should be that countries in financial hardship can go to an international court with guarantees of equality under the laws that relate to their investors, whether or not those investors are vulture funds. At moments like that, investors have more legal resources than do the countries [that are suffering financial hardship], and that situation is not reasonable. The International Monetary Fund is worried about this, and with good reason.”
Regarding the question of whether it is possible to neutralize the power of the vulture funds, the best way to act, according to Corbacho, “is to fulfill commitments; not to exceed the amount of the loans applied for; not to choose bonds as the easy way out, and to work hard to find a settlement that all parties can agree with.” He adds that “this case demonstrates that you cannot ignore any of the parties, because all of them are protected by the law. That’s why they undertook the transactions under the legal guarantee of a location such as New York.”
Spotorno points out that this issue was discussed at the beginning of this century, but later seemed to lose relevance. “In 2001, when Argentina entered into default, a consensus emerged that it was better if economies [with serious debt problems] entered into default rather than have international organizations [such as the International Monetary Fund] finance these countries’ debts. When this issue was discussed, people considered the possibility of an international law for sovereign defaults.”
But Corbacho says that Fernandez de Kirchner could be motivated by another factor. “She is worried about how history will look at this, and she doesn’t want to end her term in office with a default,” he notes. “That [sort of event] would be a demonstration of her government’s incapacity, while she believes her government can be characterized as [having led her country through] a ‘decade of achievement.’”