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Thursday, Nov. 29, 2012

EDITORIAL

The Argentine debt mess

Argentina received a Thanksgiving surprise from U.S. Judge Thomas Griesa, who ruled last week that the Buenos Aires government must pay $1.3 billion to holders of defaulted debt. The decision has infuriated the government of Argentine President Cristina Fernandez, members of which likened the judge to a vulture and called his ruling a form of "legal colonialism."

More than just Argentine pride rides on the appeal, however: Mr. Griesa's decision has potentially sweeping implications for debt restructuring and could damage the United States' status as a center for future deals.

In 2001, Argentina defaulted on $95 billion of debt. It subsequently commenced negotiations with creditors and reached agreement with 93 percent of bondholders to restructure its debt in 2005 and 2010 and to make repayment of 30 cents on the dollar over 30 years.

A few creditors held out, including some that bought the debt after default; they demanded full repayment. Argentina's position has been that it has no obligation to pay those holdouts, and that it can instead favor bond holders that restructured.

The holdouts have pursued the government in court and have occasionally had property seized: An Argentine naval vessel was recently impounded in Ghana, triggering a minor diplomatic crisis between the two countries.

Mr. Griesa had previously ruled that Argentina had to pay the holdouts if it planned to pay anyone, basing his argument on the "pari passu" or "equal step" clause in the new bond agreement. Argentina appealed and in late October, the appeals court confirmed the original ruling with a call to clarify two points, which Mr. Griesa dutifully did in his ruling last week.

In that ruling, he ordered Argentina to pay $1.3 billion to the holdouts — the face value of the bonds they hold plus a decade of interest — when it pays holders of the restructured debt on Dec. 15 and to deposit the money in an escrow account pending yet another review by the appeals court.

At the same time Mr. Griesa ordered Argentina not to change its payment mechanism, saying that third parties helping it pay the restructured bondholders would be considered aiders and abettors.

Ordering full payment to the holdouts was a surprise. Mr. Griesa had the discretion to order some payment, but not all of it. Apparently, angered by Argentina's insistence that it would not pay anything to the holdouts, he opted for 100 percent and lifted a stay on payment while the ruling is being appealed.

Equally surprising was his decision that any party that helps facilitate payments to the restructured creditors — such as major banks in New York that act as intermediaries — would be complicit and in violation of his order.

The ruling puts Argentina in a dilemma. If it does not pay the full amounts as required, then it cannot pay the other bondholders and that would constitute a default. At the same time, however, Argentina's domestic law bans it from reopening the restructuring, which is what paying the holdouts would do.

The government also worries that if it pays the holdouts, then other holdouts — and there are enough to increase liabilities 500 percent — will demand to be paid too. And if they get full payment, the creditors that restructured are likely to go to court as well.

To be clear: Argentina has the money to pay the holdouts — all of them. It chooses not to.

Basically it argues that paying the holdouts will undermine future debt renegotiations; why would any party accept any renegotiation if a holdout can ultimately get full repayment some time in the future?

More to the point for Ms. Fernandez, the decision is a violation of Argentine sovereignty. For her, the government has made decisions about payments that reflect the needs of the nation, which override those of creditors, especially after renegotiation.

The original negotiations over restructuring reflected the government's demand to subordinate debt to its independence. It would repay those creditors that respected Buenos Aires' priorities.

More controversially, Ms. Fernandez argues that the debt is tied to borrowing by the military junta that ran the country in the 1980s. Paying the debt is, in her eyes, legitimizing that government. That claim is controversial since those debts were restructured in 1992 and the subsequent default in 2001 reflected the extravagance of the democratic regime that followed the generals.

There are concerns that the ruling could hurt New York's status as an international financial center. Mr. Griesa's ruling will trigger strict scrutiny of the pari passu clause in other deals and concern about how they will be enforced and the rights of holdouts.

The prospect that intermediaries — the banks that hold and transfer coupon payments — could be penalized as accomplices will encourage deals to be done outside the U.S. financial system; instead they will use financial firms with no U.S. presence.

Finally, the ruling threatens the protected status of international financial institutions like the World Bank and the International Monetary Fund, which have been key players in most sovereign debt restructurings.

There is a way out of this mess. The New York Appeals Court could stay enforcement of the ruling or parts of it. Ultimately, however, it is likely that the government of Argentina will have to moderate its position and accept some form of compromise.

That will be difficult and constitute a real embarrassment for Ms. Fernandez. But she has no one to blame for those difficulties other than herself. Her harsh rhetoric has backed her government into a corner, which is always a bad place from which to govern.



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