Now that Argentina, in the midst of a political whirlwind, has defaulted on its debts to creditors the world over, those creditors face a difficult choice: Whether to grab assets or just wait for the offer of a repayment deal.
Both options are risky, and Argentina has had enough problems scrambling to form a government, let alone agreeing on a policy for dealing with creditors.
The chaos has left bankers, lawyers and academics alike wondering whether matters could have taken a better turn had there been a third way.
PHOTO: AP
In particular, the IMF recently suggested offering countries the same sort of bankruptcy reorganization procedures, through an international tribunal, that are available to companies and municipalities in the US and other industrialized Western countries.
The idea, which has been around for at least a decade, was revived by no less a person than Anne O. Krueger, the No. 2 official at the IMF, in a November speech.
One of the first to propose this idea was Jeffrey D. Sachs, the Harvard economist well known for his work advising Russia and other Eastern European countries after the fall of Communism. "It's not just economists pushing some flaky economist's idea," Sachs said in an interview last week. "I've always regarded it as needed because it's just incredibly messy how things proceed in these instances."
For three decades, an average of one country a year has defaulted on its national debts. On some occasions, big American financial institutions and their customers lost billions of dollars in heavily leveraged portfolios that relied on the high returns of other countries' risky bonds. When those portfolios collapsed, they brought the markets -- and sometimes individual investors' wealth -- down with them.
Argentina alone owes US$141 billion, mostly to the IMF, the World Bank, other countries and institutional investors -- though its default won't be so dire.
David A. Skeel Jr, a bankruptcy expert at the University of Pennsylvania's law school, says the bankruptcy idea has promise. "At least in concept, this idea of an international bankruptcy tribunal makes a lot of sense," he said.
In an interview, Krueger said one motivation for resurrecting the idea was an increased diversity of creditors. Talks between debtor countries and creditors were easier, she said, when only a few governments and big banks were involved.
No `real world' relevance
But skepticism prevails among those for whom debt crises matter in a material sense, not just a theoretical one.
"It's a complete nonstarter as far as I'm concerned," said Hans Humes, a managing partner at Van Eck Capital, which holds some of Argentina's bonds. Humes, who said he fears that a bankruptcy process would be slanted toward debtor countries, acts as a spokesman for the Argentine Bondholder Committee, a group of private creditors.
Walter B. Wriston -- a former Citicorp chairman who once advocated bank loans to third-world countries by famously saying that "countries don't go out of business" -- agreed. "It's an idea that doesn't really have any relevance in the real world," he said.
The three stages of the process proposed by Sachs, and later by Krueger, will be familiar to those who know Chapter 11 (for companies) and Chapter 9 (for municipalities) of the US Bankruptcy Code. First, a country would receive legal protection from debts. Then, as restructuring discussions proceeded, a creditor would keep the country supplied with cash in return for priority in repayment -- like the "debtor in possession" loans recently obtained by, say, Enron Corp. Then, when creditors reached an agreement, a form of majority voting would ensure that no dissenters delayed the process.
Sachs said two other methods of resolving countries' debt crises had been tried in other countries, without complete success.
Bailing out countries by plowing money into them, as the IMF did for Russia in 1998 with US$22.6 billion, was startlingly expensive, he said. It also gave other countries incentive to behave less prudently, knowing rich nations would always be a backstop.
Getting the market to sort things out with voluntary agreements between creditors and debtors, as in the case of Ecuador's default on its public debt in 1999, did not work either, Sachs said. Some lenders held up negotiations by insisting on better terms, while a majority of creditors were willing to accept lower payments. "The free-for-all -- letting the market do it -- doesn't work," he said.
Marcus Miller, an economist at the University of Warwick in England, agreed that a stubborn minority could present a serious problem. "The signal going out from all these holdouts to everyone else is, `You're a sucker,'" he said.
But Miller said some market mechanisms could still work in the short term. In the event of default, for instance, some bonds offer increasingly worse terms to holdouts as more and more creditors accept repayment deals. Either the holdouts agree to participate or they are left with something whose worth continues to fall. Nervous investors, however, might not want to hold such debt. "You have to ask yourself how long you can have these bonds with loopholes in them," he said.
Having a permanent system would be better, Miller said. "Argentina is almost the case that proves that you have to have procedures," he said. "There has to be some way that you can stop the clock."
Sovereignty an issue
Still, getting countries to agree to give up some of their sovereign rights would undoubtedly be tough -- yet that is exactly what submitting to a bankruptcy tribunal would imply.
To prove the point, Wriston, the former Citicorp chairman, cited New York City's bankruptcy in the 1970s. "What it got down to at the end of the day was, `Do you want a federal judge to tell you how many cops you can hire?'" he said. Though the answer might have been yes in New York, it is more likely to be no for, say, Argentina and an international bankruptcy tribunal.
"A city or town is not analogous to a country," he said. "We have very few armies in New York. There's nothing the IMF can do about the internal affairs of the country."
Virtually every country would have to pass laws acknowledging the powers of the tribunal, said Mark Shapiro, who jointly leads Shearman & Sterling's bankruptcy law practice. "Any country that did not pass such a law would be a major hole in the system," he said by e-mail.
A creditor in a country that did not sign on to the IMF's plan could still sue for repayment, Shapiro said, adding, "So without universal passage by all nations, which is difficult, if not impossible, given the different way that different countries approach creditors' rights issues, this would not work."
But Sachs said that even a tribunal with limited powers could succeed. "Chapter 9 is a case where you can't seize the assets, you can't change the management and you can't interrupt the functioning of the government," he contended, yet its procedures have worked.
The idea of a bankruptcy tribunal has already garnered some support from Treasury officials, including Secretary Paul H. O'Neill. "Clearly, it's something that Secretary O'Neill had mentioned a few months ago, and something that he thinks is an important discussion to have," said Tony Fratto, a Treasury spokesman. "We welcome new ideas," he said, adding that the department would consider Krueger's proposal.
Conflict of interest
Even if the political issues were resolved, would administering a bankruptcy tribunal be a proper role for the IMF, itself a creditor?
"It's just a potential conflict," Shapiro said. "You can't be the one who's running the process as a so-called neutral party and also have a stake in the outcome."
Wriston said the IMF's special standing, even among creditors, could further jaundice the proceedings. "The IMF and the World Bank have enjoyed priority payment even though they don't have it legally," he said. "They get it because countries want to stay on their good side."
Sachs said the IMF's special standing could help, not hurt, a tribunal. He suggested that the IMF was the natural choice to supply working capital to a country.
That the impetus for a bankruptcy tribunal finally came from within the IMF, rather than from its member governments, may be no coincidence. In 1999, two years before joining the fund as director of research, Kenneth S. Rogoff, then a Harvard professor, wrote a treatise on methods for resolving debt crises. In the article, published in The Journal of Economic Perspectives, he surmised that an international bankruptcy tribunal could help world financial stability if it had real power in debtor countries, as Krueger proposed.
One objection to an international tribunal is that it may result in many bankruptcies. Developing countries have roughly US$2.6 trillion in outstanding debts. Default should not be made too painless, said William R. Cline, chief economist at the Institute of International Finance, an industry research center.
"Creditors who lend to sovereigns have no physical collateral," he said. "They can't seize a house or seize a building or factory. The principal counterpart of collateral for sovereign lending is the knowledge that a country will find it very difficult to borrow in the future if it defaults."
"If it looks easy to default," he added, "then there's no point lending the money in the first place."
Skeel, of the Penn law school, said that balancing the interests of creditors and debtors was not easy. "For almost the entire 19th century, the folks who wanted a bankruptcy law were creditors," he said. "They wanted a way to somehow get something out of the insolvency process. But the price of doing something was enacting a system that was very favorable to debtors."
"Countries aren't going to play unless you give them some favorable restructuring terms," he said.
The complexity also presents a formidable foe to a bankruptcy tribunal, said Paul Dickson, a portfolio manager for J.P. Morgan Fleming Asset Management. His company holds Argentine debt but is not part of the bondholder group.
Body faces obstacles
"The reality is it's incredibly complicated to come up with a body to deal with these things," he said. "Every situation is going to be dramatically different."
He said that existing processes offered the advantage of speed. "The issue is that the markets want to move very quickly," he said, while public policy tends to move slowly.
Cline shared his worries. "The likelihood is that there are much simpler solutions to the rogue creditor problem involving less overkill with lower side effects," he said.
When left to their own devices, creditors can, in theory, try to force repayment by suing a country, interrupting its trade or seizing its assets. But these measures are not always effective.
"When Ecuador defaulted, it was the general view that even state enterprise oil shipments on the high seas could not be seized at ports," Sachs said.
French court officers highlighted these difficulties when they tried, unsuccessfully, to seize a Russian fighter jet at an air show near Paris last June. A judge had ruled that the jet constituted collateral for defaulted Russian debt held by a Swiss financial company. But the French authorities permitted the jet to fly back to Russia.
Argentina might have defaulted sooner and more peacefully were it not for the threat of legal action, Miller asserted. "They said, `We can't, because we're scared of the New York lawyers.'"
"If anything, the case of Argentina is one that demonstrates the power of foreign creditors," he added. "The country fell over backwards" to avoid offending bondholders abroad.
Michael P. Richman, a partner at Mayer, Brown & Platt who represents the Argentine Bondholder Committee, said a lawsuit in New York was an option. For the bulk of its bonds, he said, Argentina waived its immunity from lawsuits brought in the United States or Britain.
But Humes said those lawsuits might not be so fruitful. "If you litigate under these bond documents, you can get a judgment in the UK or in New York," he said, but countries can hide assets from the courts.
He said the IMF could improve its proposal by ensuring a full accounting of a country's sources of income, like tax revenue, tariff collections and proceeds from national industries. "We'd have to formalize it in writing," he said. "The way that we've seen this thing pitched seems to be very heavily weighted in favor of the borrowers."
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