Argentina's sovereign debt dispute: Spot the vulture

States like Argentina hoot that they are victims of greedy market forces to wriggle out of their obligations. Maybe they are the vultures, preying on the good will of everyone else?

Spot the vulture
Charles Crawford
On 28 November 2012 15:03

I suspect that many Commentator readers are going about their business without paying much attention to battles in the New York courts over Argentina's sovereign debt.

When governments cannot raise enough money from taxes to pay for their various schemes, they borrow it on local or international markets. Thus the fascinating question for foreign lenders: will this government pay back the money it has borrowed?

In principle, no problem. Governments might be expected to behave decently (defaulting on debt besmirches national honour). Plus governments can to raise taxes or inflate the currency and somehow find the money needed to keep foreign creditors happy.

However, down the ages, all sorts of ingenious excuses have been used by governments to avoid fulfilling their responsibilities, and defaults have taken place. Defaults come with a cost. Lenders lick their wounds and for a while are cautious about lending to that country again.

As large sums of money are involved, fiendishly complicated rules have emerged for managing situations where governments can't or won't pay their debts (see the prolonged writhings of Greece). Sometimes debts are written off in large part or completely, or the period for repayment is extended well into the future. It boils down to the same thing. Lenders take a hit.

Hence the question: which lenders take which hit? Should other sovereign lenders or perhaps, for example, the IMF do better amidst the carnage than private sector lenders? And as always the mega-question: who decides?

This new case in the New York courts tackles some of these problems head-on.

Back in 2001 Argentina defaulted once again on its sovereign debt and "restructuring" took place. However, two hedge funds (aka 'vultures' that speculate on weak states’ sovereign debt problems) have objected to losing out from this process and have taken the issue to court. The judge has ruled in their favour, but more importantly has issued an order stopping third parties from "aiding and abetting" violations of his ruling. This deters banks from making payments to other creditors under the restructuring deal, creating disarray in the wider restructuring process and other Argentinean financial transactions.

Expensive consternation. Could this decision force another Argentinean default in which everyone loses even more? More lawyers pile in and start filing appeals.

How far does this case matter? These days bond agreements typically contain "collective action" clauses that allow a certain majority of bondholders to force 'holdouts' (i.e. the hedge funds in this Argentinean case) to sign up to an agreed settlement. So this problem can't arise.

On the other hand, when governments default, private creditors traditionally have found themselves towards the sad end of the line of creditors. They have tried to hit back by seizing physical assets owned by those governments (ships, aircraft) but usually fail because of "sovereign immunity".

This New York case opens the way for a fascinating new approach, allowing creditors to go instead after flows of money to those governments. So a lot is at stake (or at least may be) for the way governments deal with private creditors.

Interesting – but unimportant? Don't all creditors take the likely creditworthiness of borrowers into account and price that into their business strategy and interest rates?

These problems are fascinating because they cast light on how we look at the moral responsibility, and who bears the cost when people behave irresponsibly.

All government comes complete with vast moral hazard. Government asserts to itself the sole right to use force to compel people on its territory to pay money for causes it proclaims worthy (taxes). Plus government then asserts to itself the right not to pay back debts or to keep its promises, all under the banner of sovereign immunity. Governments as lenders barge to the front of the lenders’ queue when other governments default.

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