Saturday, November 29, 2014

Argentina’s Griesafault

NEW YORK – On July 30, Argentina’s creditors did not receive their semiannual payment on the bonds that were restructured after the country’s last default in 2001. Argentina had deposited $539 million in the Bank of New York Mellon a few days before. But the bank could not transfer the funds to the creditors: US federal judge Thomas Griesa had ordered that Argentina could not pay the creditors who had accepted its restructuring until it fully paid – including past interest – those who had rejected it.

It was the first time in history that a country was willing and able to pay its creditors, but was blocked by a judge from doing so. The media called it a default by Argentina, but the Twitter hashtag #Griesafault was much more accurate. Argentina has fulfilled its obligations to its citizens and to the creditors who accepted its restructuring. Griesa’s ruling, however, encourages usurious behavior, threatens the functioning of international financial markets, and defies a basic tenet of modern capitalism: insolvent debtors need a fresh start.

Sovereign defaults are common events with many causes. 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. The experiment failed, and the country suffered a deep economic and social crisis, with a recession that lasted from 1998 to 2002. By the end, a record-high 57.5% of Argentinians were in poverty, and the unemployment rate skyrocketed to 20.8%.

Argentina restructured its debt in two rounds of negotiations, in 2005 and 2010. More than 92% of creditors accepted the new deal, and received exchanged bonds and GDP-indexed bonds. It worked out well for both Argentina and those who accepted the restructuring. The economy soared, so the GDP-indexed bonds paid off handsomely.

But so-called vulture investors saw an opportunity to make even larger profits. The vultures were neither long-term investors in Argentina nor the optimists who believed that Washington Consensus policies would work. They were simply speculators who swooped in after the 2001 default and bought up bonds for a fraction of their face value from panicky investors. They then sued Argentina to obtain 100% of that value. NML Capital, a subsidiary of the hedge fund Elliot Management, headed by Paul Singer, spent $48 million on bonds in 2008; thanks to Griesa’s ruling, NML Capital should now receive $832 million – a return of more than 1,600%.

The figures are so high in part because the vultures seek to earn past interest, which, for some securities, includes a country-risk premium – the higher interest rate offered when they were issued to offset the larger perceived probability of default. Griesa found that this was reasonable. Economically, though, it makes no sense. When a country pays a risk premium on its debt, it means that default is a possibility. But if a court rules that a country always must repay the debt, there is no default risk to be compensated.

Repayment on Griesa’s terms would devastate Argentina’s economy. NML Capital and the other vultures comprise just 1% of the creditors, but would receive a total of $1.5 billion. Other holdouts (6.6% of total creditors) would receive $15 billion. And, because the debt restructuring stipulated that all of the creditors who accepted it could demand the same terms as holdouts receive, Argentina might be on the hook for $140 billion more.

Every Argentine might thus owe more than $3,500 – more than one-third of average annual per capita income. In the United States, applying the equivalent proportion would mean forcing every citizen to pay roughly $20,000 – all to line the pockets of some billionaires, intent on wringing the country dry.

What’s more, the existence of credit default swaps creates the possibility of further gains for the vultures. A CDS insures against a default, paying off if the bonds do not. They can yield substantial returns, regardless of whether the bonds are repaid – thus reducing their holders’ incentive to achieve an agreement.

In the run-up to July 30, the vultures conducted a scare campaign. A second default in 13 years would be a big setback for Argentina, they claimed, threatening the country’s fragile economy. But all of this presumed that financial markets would not distinguish between a default and a Griesafault. Fortunately, they did: Interest rates for different categories of Argentine corporate loans have not reacted to the event. In fact, borrowing costs on July 30 were lower than the average for the whole year.

Ultimately, though, the Griesafault will carry a high price – less for Argentina than for the global economy and countries needing access to foreign financing. America will suffer, too. Its courts have been a travesty: As one observer pointed out,it was clear that Griesa never really fathomed the issue’s complexity. The US financial system, already practiced at exploiting poor Americans, has extended its efforts globally. Sovereign borrowers will not – and should not – trust the fairness and competence of the US judiciary. The market for issuance of such bonds will move elsewhere. 

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    1. CommentedJoshua Ioji Konov

      Under the current trickle-down Capitalism's Economics this article is very correct to criticize the judge decision, however, it could be said that the whole system of issuing securities without proper insurance, and without proper business plan to prompt business activities in the case by Argentina is a system that has to be enhanced moreover changed from the shadow economics lacking the rule of law in business (national and international) into a strict by the rule of law such, whereas insurance, bonding, etc applies yo issuing securities, as well personal responsibilities does too!

    2. CommentedClaudio Migliore

      As I have already pointed out in comments to other participants of this campaign, I think there are two forces at play here beyond academic thought. One is ideology pure and simple. although obvious in some articles more than others.
      The other, sadly, might be in some cases corporate and individual self interest. Individual interest comes in the form of speaking engagements in the countries involved, paid show of support tours, honoris causa degrees from local universities, etc. The corporate interest for the economics profession lies in the lure of creating yet more international bureaucracy to 'help' by, for instance, arbitrating on sovereign defaults, where chairs, analysts, consultants, friends, can produce, and bill for, metric tons of paper, ink or hopefully just terabytes of opinions.
      Though not everyone may be conspiring or committing any impropriety, too many anecdotes are out there pointing to what I think goes on in general, sadly.

    3. CommentedWilliam Wallace

      Yet another egregious example of how financial markets are 'regulated' to favor speculative and harmful behavior. Financial markets ought to be considered subordinate to the real economy and be regulated accordingly. After all, every time the bets go bad, investors come begging (pillaging) real markets for their losses. To treat what are essentially gamblers as equal and good faith contributors to the economy is what the neocon mantra is really all about.

    4. CommentedKevan Salisbury

      Dr. Stiglitz and Dr. Guzman,

      I have a great deal of respect for your economic theories, collectively. However, I think that perhaps your social viewpoints tend to color your perspective on what is actually a case of law and finance.

      Argentina is a story that has already happened recently, with quite a bit less pomp and fanfare. I am referring to Greece, which was faced with a similar situation. They were able to change local law bonds to require bondholders to accept a majority cramdown for restructuring, but unable in most cases to do so for their foreign law bonds. In the case of the CHF-denominated bonds, they failed to achieve a quorum to vote at all. The solution? They have been paying these coupons, and presumably will pay the maturity in full. Even as they defaulted and restructured the GGBs. Most new sovereign debt now contains collective action clauses as a consequence.

      Argentina chose the legal language for their bonds. They chose to issue under NY law. They did these things because it reduced their cost of borrowing, and allowed a kleptocratic regime to buy new toys.

      This is deeply unfair to future generations; to a lesser degree I understand President Kirchner's refusal to engage at all in the discussion. But politicians cannot simply ignore a situation because it is not of their creation; this was a political act. There was a choice not to engage in negotiations, where a settlement could have failed to trigger the additional clause expiring in December. Holdouts are often paid for this very reason: because the alternative is far too costly.

      Sirs, your knowledge and ability to educate is truly astounding. But I feel as though your hearts may drag you into areas that are not as flattering to your intellectual reach.

      KF Salisbury

    5. CommentedNicolas Cachanosky

      Stiglitz & Guzman on Argentina’s “Griesafult”

    6. CommentedRichard H. Serlin

      "...and defies a basic tenet of modern capitalism: insolvent debtors need a fresh start."

      Maybe modern compared to all of world history, but still going back at least hundreds of years. The founding fathers put bankruptcy in the constitution.

    7. CommentedDavid Cearley

      On the hook for $3,500? ) Obama has put American on the hook for more than $60K in debt during just one term. A bad deal for the citizens? All Argentina is being asked to do is repay debt that's already been restructured. Money their government agreed to pay and money they actually spent. After all, it's government corruption and policies that created this mess, not banker who agreed to lend them money.

    8. CommentedHugo Pezzoni

      I fully disagree with Doctor Stiglitz and Doctor Guzman. They are viewing this problem very narrowly, which speaks poorly about them given their status of scientist and academics. A broader view would take into account the fact that in the case of Argentina, there has been a very corrupt government that has spent many times the amount owed to the holdouts in criminal activities: appointing 80 thousand paid militants, overpricing public works for billions of dollars on condition that the "entrepreneurs" being awarded the work return a portion of such overprices to the Kirchner family and other prominent members of the Administration, paying high salaries to members of the government not disclosed to the public or in government budgets, buying government owned assets at ridicule prices, order infrastructure projects in order to enhance the value of those acquired assets and sell them at market values after the infrastructure works have been completed.
      I think the judgement from Thomas Griesa is good for Argentina. Politicians will know that defaulting is no longer a free ride.

        CommentedJ. C.

        Amen. Dr. Stiglitz is a political operator from long ago. Hi is the guru of self-praised populist third world leaders...

    9. CommentedROBERT BAESEMANN

      On 7/24/2014 Floyd Norris wrote about the Court's problems with Argentine debt. According to Norris, Citibank of Argentina is a key player in this situation. That CDS have a role here seems to suggest that seucitized Argentine bonds are in play here, which means there are toxic assets out there on someone's balance sheet. I hope I worry needlessly, but this seems to suggest that short sellers could soon target a major bank like Citibank, which might have hidden toxic assets on the books of its Argentine subsidiary. I hope that more knowledgeable people than me can assuage my fears.

    10. CommentedEmilio Perez

      Unfortunately, "a debt is a debt" and this one started with Arg President Carlos Menem, who ripped some of this debt for his own enrichment (bought a 747 and built a landing strip in his own ranch). There are many negative and stupid factors that created this situation and unfortunately in order to save Argentina Nestor Kirchner signed something that look good at that time but it is a worst deal. Argentina failed to read all small words and the US is famous for adding a lot a small words to International Agreements regarding debt.

      We all know that Mr. Singer is much more than a vulture, but business is business and Argentine basically felt for it. There are many ways to make Singer pay for this and accept terms as accorded, but it will take astute Argentinians and they lack of it.

    11. CommentedArda Ohannessian

      Some have more power, but we are all interdependent on this planet. It is good to succeed, but not at any (destructive) cost to those whom you 'defeat'. Rules and laws (national and international) should be made with that in mind. Power is more a responsibility, rather than an absolute prerogative to be exercised willy-nilly. Some countries (including Argentina) are far less sovereign than others on the great planetary playing field. We the rich countries have put them in that position. Let us make sure we play fairly.

    12. CommentedJose Oyola

      Corrections to the opinion piece by Stiglitz and Guzman:

      1. "Sovereign defaults are common events"
      Sovereign defaults are extremily RARE events that occur cyclically in a small set of countries, like Argentina.
      Evidence: Moody's Sovereign Research in

      2. Sovereign defaults are the result of wrong policies pursued in the defaulting states, like Argentina, which fixed its peso to the US dollar and borrowed billions in foreign-denominated debt to finance budget deficits for many years.

      3. Research shows that an effective way to encourage sound policies among the small group of sovereign defaulters is to restrict their borrowing access to DOMESTIC investors only. This restriction forces governments to internaliza the costs of their sovereign defaults. Inother words, the residents benefited who benefit from excess borrowings also beat the cost of sovereign defaults.

    13. CommentedEnrique Woll Battistini

      Where's the fairness in allowing borrowers to default on their repayment commitments? Credit Default Swaps, as defined herein, pay only if defaults occur, that is, for cause. Blaming the victims -the bondholders or CDS holders- for exercising their rights is not elegant. Ultimately, citizens are responsible for the type of government they have.

    14. CommentedDavid Martin

      Wrong Christopher,
      We, the people of the United States of America, know of the unscrupulous activities of the conservative-packed Supreme Court, the Conservative majority House of Representatives and the Wealthy Elite, who actually run this country with payouts to corrupt government officials, acting unconstitutionally, as their legislative acts are loyal to corporations and wealthy elitists, rather than to the majority of American citizens. Professor Stiglitz also coined this very real phrase of ""Regulatory capture," and "Cognitive capture," which will give you the education you will need to comprehend my argument.
      Obviously, the hi-jacking of Black wealth and poor wealth, in America without any accountability, doesn't resonate with you when one states we have an accountability problem, which renders our New York Financial Court system as illegitimate. Even with Wall Street thieves getting a way with predatory lending practices by taking advantage of financial novice to circumvent expected legal practices of accounting, but then extorting by setting up desperate customers, you know will default because you have not been regulated, due to a Congress that will not fund regulators, so these corrupt entities then lend money to those not qualified for loans, then expect them to pay back at a rate double and triple that from which they have come to you, because they were having problems with the contractual obligations they already had in place. This is an act of predatory tactics. You know this, but since you are one of the vultures, complicit in this unconstitutional act; because you have not been held accountable, you believe it is okay to extend this dangerous game of deceit to other nations. You, and your cronies are setting this nation up for never-ending violent aggression toward us, because you have serious mental issues of greed, at any cost.
      Griesa is yet another conservative pansy for the corrupt conservatives in this nation, now exporting their own form of terrorism and must be held accountable for his acts. Those complicit in these acts, such as yourself, should be held accountable for the stealing of so much wealth in America and then transferring that wealth to offshore accounts, to escape your constitutional obligations to pay taxes on those dollars that were being taxed, but now, in your hands are not, leading this nation dangerously to the brink of financial collapse.
      You are knowingly practicing in this unconstitutional act, knowing that others will not trust our markets in the future, because you are knowingly destroying our reputation, which is a terrorist act against the Constitution and the people of the United States, just as a terrorist.
      Now, you have the audacity to argue that this new tactic to use this same modus operandi in another nation and claim they must adhere to these, already established illegal terms, on a nation of people not savvy in the accounting practices enough to recognize this deceit. You are not only an evil SOB, you're an ignorant one.
      One would hope that the State Department and other government officials are looking at this and will investigate U.S. Federal Judge Thomas Griesa for deploying the same acts that facilitated the near financial collapse of the U.S. in 2007-2008 and now exporting that same tactic, because not one Wall Street "perp" was held accountable for said acts.
      And, by the way, this is not law, it is circumventing the law to fit your needs and since you have the wealth, house and Supreme Court backing you, for corrupt reasons, it is criminal. This, as the potential genocide in Erbil, Iraq, will not happen in Argentina, with our new ethos of "Never Again".

    15. CommentedDouglas Costello

      Chapter 11 should provide for those who fail to understand the International Monetary system and Sovereign risk a basic guidance. Interest is the risk premium for borrowing and Sovereign Nations can not be held to account by the Judiciary of another nation. Argentinian risk is judged by those prepared to lend by the interest rate they demand and the period of loan they are prepared to accept.

        CommentedChristopher Goodwin

        Wrong, Douglas. The whole point about a New York judge ruling on an obligation by a foreign government is that said foreign government issued its paper in New York, and accepted New York Law. Argentina may well have "fulfilled its obligations to its citizens and to the creditors who accepted its restructuring." But it has, under New York law, still got obligations to those who did NOT accept the restructuring. That is what acceptance means, a voluntary agreement to a change. Insofar as the change is not acceptable, then, under New York law, the owner of the paper retains rights, and the foreign government retains obligations, which must be treated pari passu with the liabilities payable to the CWAR. It is not economics 101, it is not even economics, it is none of Stiglitz/Guzman 's business, it is law.

    16. CommentedJoe Johnson


      I don't understand why you seem okay with absolving Argentina of any fault in this scenario. Sure, Argentina deserves a chance to start over, like any other entity that declares bankruptcy. But, when there is a private company and debtors are not in agreement, the creditors asking for more protections are not discarded like a flyer handed out in Times Square.

      Argentina has the means and assets to structure some sort of agreement with the creditors. However, Argentina has a plethora of nationalized assets that is could sell or deliver to satisfy its obligations (which it reneged on).

      But, nice slant piece Stiggy.

        CommentedRobert Lunn

        Bunk! If they followed the Bankruptcy law in the U.S. various harmed classes vote on payouts and restructuring. So, if a super majority, (for example 2/3rd) agree on an amount, that's what gets paid. Those 1/3rd holding out do not get par.
        I find this interesting although I don't know New York law but if a settlement is reached common sense tells you no debtor would agree knowing the New York Judge will give him his investment in full.

    17. CommentedVan Poppel charles

      Mr Stiglitz, as Nobel price economist, has he nothing else to do than meddling up with a sovereign debt problem; when you hire the money, you should pay it back.

        CommentedSiegfried Eschen

        I agree. It looks like the Argentine government and the political party of the Argentine president sell themselves as being social democrats. They are neither, social nor democrats. They do not abide the rule of law, do hinder the freedom of the press and threaten people, who do have a different opinion, using the Argentine IRS which visits these 'offenders' at night.
        It is a shame, that people like professor Stiglitz, Martin Guzman, professor Saskia Sassen and the UK newspaper The Guardian, support this almost dictatorial regime.
        I do not want to assume, these people and this newspaper have been paid in order to misinform the public. It is very disappointing to see these people publish opinions not aware of the destructive policy of this government. The poor (30-40% of the population) and at least the next two generations will have to pay for this debt, I am afraid.

    18. CommentedTerrence Moloney

      What about the terms of the bonds? Like many economists, Professor Stiglitz and Mr Guzman simply assume that the Judge was supposed to come to a result that made the most economic sense. But that is not the role of a judge; he's meant to rule on the meaning on the notes and ruled that the pari passu clause binds Argentina to pay the holdouts in accordance with the terms of the original notes. Argentina has the right to appeal, of course, and I believe it has, but if the authors suppose the ruling jeopardizes international capital flows, imagine a scenario in which the rule of law no longer mattered, and someone could sweep in and say, 'well, it's those nasty vulture funds that are the creditors, and we're not going to pay them'.

      The rule of law matters. Without it, there'd be no international capital markets. Argentina knew it would be subject to the rulings of a NY judge when it sold the bonds. It knew third parties might buy those bonds on the open market. It must grow up and deal with the consequences.

      It frankly doesn't matter who holds the notes. Vulture funds or the sister of mercy in india. The judge looks to the law and the language of the notes, not the character of the note holder.

      Lastly, it makes no sense to say there is no default risk if a court rules there's always an obligation to pay. Courts always rule there's an obligation to pay; a default occurs when someone doesn't pay DESPITE an obligation! This is, I am sorry to say to such eminent writers, basic stuff.