A years-long court battle in New York could have major implications for the world’s financial system as investors seek to recover unpaid debts from Argentina’s massive 2001 default.
Global finance officials fear a victory by creditors could make it more difficult to put together an international financial rescue package like the one that pulled the Greek economy from the brink of collapse in the past few years. Those concerns have put the US government and the Washington-based IMF in an awkward position. They have both criticized Argentina’s handling of its economy, but they fear a judgement against the Latin American country in the case could set a dangerous precedent.
“It has nothing to do with Argentina,” IMF spokesman William Murray said on Thursday last week. “It has to do with the principles, the policy implications of a particular legal case.”
The concerns arose again last week as the IMF contemplated formally backing Argentina in the court case. After the US opposed that plan, the international lending agency decided against doing so, saying it was wary of taking sides in a US legal dispute. However, the IMF clearly worries that a ruling against Argentina could make it difficult to craft future rescue packages that call for a country’s creditors to accept less than what they are owed.
The US, which has supported Argentina at earlier stages of the case, said on Wednesday last week that it shares the concerns, even though it had opposed IMF involvement in the case. The IMF was considering filing a friend-of-the-court brief in support of Argentina’s petition to the US Supreme Court to overturn a lower court’s ruling against it.
The case stems from Argentina’s financial crisis a dozen years ago, when the government could not pay its debts and Argentine bonds became nearly worthless. As the country tried to get its finances in order, it offered creditors new bonds that initially paid less than US$0.30 for each dollar of bad debt. More than 90 percent of bondholders agreed and some of them have since recovered three-quarters of their pre-default investment, but a small fraction of bondholders, some of whom bought the debt securities at cut-rate prices during the crisis, say Argentina should pay them the face value of the bonds, plus interest. Investment fund NML Capital and 18 other creditors sued and a lower court ordered Argentina to pay US$1.4 billion.
Normally, it would be difficult for plaintiffs to collect on such a ruling. However, the judge granted their request for an unprecedented mechanism to force Argentina to pay: Using the US funds transfer system — it automatically zips trillions of dollars a day around the world — to block the payments Argentina makes to all the other bondholders unless it also pays the plaintiffs.
That worries the US and the IMF. When a country is basically insolvent, the IMF often steps in and helps craft a package that may force the country to overhaul its finances — and also pressure creditors to accept restructured or reduced debt. If the lower-court ruling is upheld on appeals, the IMF says that would make it less likely that the majority of creditors in any future bailout would agree to complex debt restructurings such as the one Greece recently went through. Bondholders would have less incentive to reduce their claims on the country down to levels where payments can be met.
“If this makes debt relief harder, the IMF’s job is made much harder,” said Anna Gelpern, senior fellow at the Peterson Institute for International Economics and a law professor at Georgetown University.
Charles Blitzer, a former IMF official and a consultant with significant experience in debt restructurings like Argentina’s, said the US and IMF concerns are overblown, and not based on evidence or careful analysis.
The ruling, Blitzer said, would only be applicable to a very few cases because the language in the bond contracts was unusual. The case revolves around clauses in the original 1990s bond contracts that gave equal rankings for all kinds of debt.
Secondly, the ruling was explicitly a reaction to Argentina’s behavior toward creditors, such as its unwillingness to negotiate and obey other court orders, Blitzer said.
He also noted many recent bond contracts have collective action clauses that allow a majority, say 75 percent, to determine whether all bondholders go along with a debt restructuring.
Blitzer said there are some serious misconceptions about why previous debt restructurings, with the exception only of Argentina, have been highly successful with acceptance rates well above 90 percent.
“The vast majority of the institutions which own sovereign bonds are in the business of only managing performing, liquid debt,” he said. “Pursuing holdout strategies simply is not part of the mandates they have from their own investors. That business focus will not change regardless of how this suit is ultimately resolved.”
The judge’s ruling to force Argentina to pay using the US funds transfer system prompted alarm reflected in a flood of legal briefs from US banks, the Federal Reserve, the US government and other institutions, warning of serious damage.
The Federal Reserve and the Clearing House, a trade group representing the world’s largest commercial banks, told the judge to make sure his order would not affect the US funds transfer system.
The entire system depends on transfers being “immediate, final and irrevocable” when processed, the Federal Reserve said. 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.”
Argentina says it cannot possibly comply with the judge’s order without ruining its economic recovery. The country has been unable and unwilling to issue new bonds in a foreign currency because of the case as it would have to pay prohibitive interest rates. Anyone wanting to insure current Argentine debt against another default must pay the highest prices in the world.
Additional reporting by Michael Warren