Joseph Stiglitz and Martin Guzman have a recent piece at Project Syndicate about the implications of Argentina’s default, or what they call “Griesafault.” In a nutshell, the piece blames U.S. Judge Griesa (Southern District of New York), rather than Argentine Republic (the debtor), for the default and argues that the court’s ruling “encourages usurious behavior, threatens the functioning of international financial markets, and defies the basic tenets of modern capitalism: insolvent debtors need a fresh start.” I’m afraid, however, that closer inspection suggests otherwise.
First, what happened? In late 2001 Argentina defaulted its debt (issued in the 1990s). The defaulted debt did not have a collective action clause (CAC). When this clause is in included in debt contracts, it means that if a debt swap is offered and a threshold of creditors accepts the exchange conditions (the “holdins”), then the other creditors (the “holdouts”) have to accept the exchange as well. The absence of the CAC means that even if 99% of the creditors accept to exchange its debt with the issuer, the remaining 1% are entitled to receive payment in the terms of the original contract.
The debt contract is very clear on this point. To suggest that because a high percent of creditors entered the debt swap Argentina should not pay 100% to the holdouts or to suggest that Argentina should pay when and if wants to is a mere difference of semantics. Either case supports a unilateral breach of contract that the courts of law cannot and should not endorse.
What about the pari passu clause? After Griesa’s ruling Argentina refused to pay repeatedly ignoring the court’s order. Because of this behavior by Argentina, the pari passu argument was brought to the court by the creditors. The pari passu means that Argentina has to treat all of its creditors equally (it cannot pay some creditors and not pay others.) Upon this presentation by the investment funds, Griesa imposed a stay to remain in place until the pari passu issue is resolved. When the U.S. Supreme Court refused to consider the Argentine’s case all judicial venues exhausted and Griesa’s stay fell. It should be pointed out that Griesa’s ruling was also endorsed by the court of appeals and his initial ruling stands in its original form.
After the stay’s fall, Argentina was supposed to pay all of its creditors on June 30th. Failing to do so, Argentina went into a grace period that expired on July 30th. Failing to pay by July 30th, Argentina defaulted its debt (a more detailed discussion here.)
There are four misconceptions in Stiglitz and Guzman’s piece.
1. The first one is that “Argentina has fulfilled its obligations to its citizens and to the creditors who accepted its reestructuring” because “Argentina had deposited $539 million in the Bank of New York Mellong [BONY].” This is incorrect on two accounts. First, as clearly stated in the bond contracts, payment is fulfilled when the deposit reaches the creditors’ accounts. Argentina transferred funds to the BONY (intermediary, not creditor) account in the Argentine Central Bank. Therefore, per the contract, Argentina did not fulfill its obligations for the same reason that a mortgage is not paid by making a deposit in a frozen account beyond the reach of the mortgage issuer. Second, no one questions the obligations of Argentina with the holdins, but there are also obligations to the holdouts. Argentina tried to pay only to the holdins ignoring the rights of the holdouts and ignoring also the pari passu clause that Argentina itself added to the bonds. Given the pari passu and Griesa’s ruling, Argentina has to pay to all its creditors, not to some of them. There is no distinction to be made between having to pay to the holdouts and the holdins now that there is a final court ruling. It should be mentioned that the absence of the CAC and the pari passu, as well as the choosing of the NY courts of law as the legal umbrella of Argentina’s debt, are all part of Argentina’s sovereign decisions. None of these are imposed conditions upon Argentina and therefore none of them can be used by the Republic to avoid its own imposed obligations. In at least two occasions, Griesa referred as “illegal” to try to pay only some of the creditors. It could hardly be considered payment an action explicitly and repeatedly considered illegal (as if this were not enough, in the hearing of August 8th Griesa is again bluntly clear about this matter; see pp. 7-8).
2. The second misrepresentation is the assertion that for “Argentina, the path to its 2001 default started with the ballooning of its sovereign debt in the 1990s, which occurred alongside neoliberal ‘Washington Consensus’ economic reforms that creditors believed would enrich the country.” Stiglitz and Guzman are correct to point out the ballooning of the debt during the 1990s, but are imprecise, if not wrong, about the implementation of neoliberal Washington Consensus’s policies in Argentina during the 1990s. This 10-rule recipe was simply not applied to Argentina. A look at Argentina’s reforms during the 1990s shows that only 4 (or maybe 5) out of the 10 Washington Consensus rules were applied in Argentina. It can hardly be argued that what failed in Argentina was a recipe that was not applied. As these authors hold, the debt ballooned during the 1990s. Since when a ballooning debt is neoliberal or consistent with the Washington Consensus that calls for “fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP” as its first point? (for a more detailed, in Spanish, discussion see here.)
At the opening of this paragraph, Stiglitz and Guzman also argue that sovereign “defaults are common events with many causes.” I’m not sure how much is common for Stiglitz and Guzman. But probably less than Argentina track’s record. Since its independence in 1816 Argentina spent 33% of its time either under default or with debt reestructuration. Since WWII, Argentina was 54% of the time under default or with debt under reestructuration. This is a “common” situation that needs to cease. Such poor performance suggest that the problem is Argentine politics and economic policy, and that this default is hardly an external legal accident imposed to Argentina.
3. The third misconception is the treatment given to risk and the assertion that “if a court rules that a country always must repay the debt, there is no default risk to be compensated.” There are two points to be made. First, a risk was taken by the investors when buying the defaulted bonds before there was a trial resolution. The risk was taking the country to trial, where the judge could have ruled against or in favor of Argentina. The investment funds won the case. They already took a risk. To argue that because investment funds should not get paid 100% of what the country owes to them because they bought high-risk bonds misses the target. Second, the ruling does not say that a country always must repay the debt. The ruling says that because it was Argentina who did not include a CAC and included a pari passu clause it has to pay (pari passu) all creditors. Should Argentina had included a CAC, the ruling could have been different. The Judge cannot be blamed for doing his job of enforcing contracts as they are written.
4. Finally, I also differ on the impact of complying with Griesa’s ruling. In addition, this is not a reason to change the underlying ruling in case (flexibility in how to pay, but not in how much to pay is a different matter.) Stiglitz and Guzman hold that repayment “on Griesa’s terms would devastate Argentina’s economy.” This is because the ruling, that now affects 1% of the holdouts, would extend to other holdouts (6.6% of total creditors). In an indirect reference to the RUFO (rights upon future offers) clause, Stiglitz and Guzman argue that total debt may increase to $140 billion (or more) pushing the debt to more than 1/3 of GDP per capita. There are three points to consider here. First, the RUFO clause, as read in the prospectus, holds that if Argentina makes a voluntary offer to exchange or buy the defaulted bonds to holdouts that is better than the one offered to the holdins, then the latter have the right to receive the better offer as well. This clause expires at the end of year 2014. The RUFO clause, does not apply for two reasons. First, complying with a court order is not voluntary, but a mandatory action. Who is ready to hold that a judge would rule that its ruling is voluntary? Second, if Argentina pays cash, there is no offer to exchange or buy the holdout bonds as the RUFO clause requires.
The second point is that this is hardly an onerous ruling for Argentina. To pay cash to the holdouts that won the trial requires to allocate between 1% and 2% of its annual tax receipts. Hardly an economic burden. Third, the fact that debt could reach 1/3 of GDP per capita might be the right number, but not the right interpretation as presented by Stiglitz and Guzman. Debt is a stock; GDP per capita is a flow. A stock/flow ratio shouldn’t be read as if the whole stock has to be paid with only one flow. This high debt does not have to be paid in one year and does not materialize immediately as other holdouts also need to go to court. Furthermore, because RUFO expires at the end of 2014, Argentina can renegotiate before other holdouts get a positive ruling in the courts of law. I think that Stiglitz and Guzman are overstating the economic impact of observing the court’s ruling.
Besides these differences of interpretation on the ruling of the Argentine vs NML case (I rather avoid terms like “vulture investors” that Stiglitz and Guzman use because I found them to be too loaded with negative connotations, more appropriate of Argentina’s domestic populist political discourse than that of an objective discussion), I see the ruling favoring rather than hurting international financial markets. This case is not subject to “contract interpretation”, but is a case of “contract enforcement.” Investors, most likely, would rather lend funds to developing countries under a court of law like NY where contracts are enforced than under Stiglitz and Guzman’s principles where the contract specifications can be ignored at the convenience of the debtor. For this reason, developing countries should welcome Griesa’s ruling because it reduces the risk associated to lend to sovereign countries. Finally, Griesa’s ruling could help countries like Argentina to achieve the so much needed but so elusive fiscal discipline that has been the root of so many economic imbalances.