Monday, November 24, 2014

A Tear for Argentina

CAMBRIDGE – Argentina’s latest default poses unsettling questions for policymakers. True, the country’s periodic debt crises are often the result of self-destructive macroeconomic policies. But, this time, the default has been triggered by a significant shift in the international sovereign-debt regime.

The shift favors hardline creditors in bond issuances governed by US law. With emerging-market growth slowing, and external debt rising, new legal interpretations that make debt future write-downs and reschedulings more difficult do not augur well for global financial stability.

There are no heroes in this story, certainly not Argentina’s policymakers, who a decade ago attempted unilaterally to force a massive generalized write-down on foreign bondholders. Economists who trumpeted the “Buenos Aires consensus” as the new way to run economies also look foolish in hindsight. The International Monetary Fund has long recognized that it made one too many loans to try to save Argentina’s unsustainable dollar peg as it collapsed back in 2001.

This is not the first time that an Argentine default has upended international capital markets. According to the tabulation that Carmen Reinhart and I compiled in our 2009 book This Time is Different, Argentina has defaulted on seven previous occasions – in 1827, 1890, 1951, 1956, 1982, 1989, and 2001.

Argentina may be almost as famous for its defaults as it is for its soccer teams, but it is hardly alone. Virtually every emerging-market country has experienced recurrent sovereign-debt problems. Venezuela is the modern-day record holder, with 11 defaults since 1826 and possibly more to come.

Back in 2003, partly in response to the Argentine crisis, the IMF proposed a new framework for adjudicating sovereign debts. But the proposal faced sharp opposition not only from creditors who feared that the IMF would be too friendly to problem debtors, but also from emerging markets that foresaw no near-term risk to their perceived creditworthiness. The healthy borrowers worried that creditors would demand higher rates if the penalties for default softened.

Recently, as an outgrowth of a reconsideration of the IMF’s lending to the periphery of Europe (and Greece in particular), the Fund has advanced another approach to debt rescheduling, one that might be easier to implement. The IMF now recognizes that the bulk of its financing was effectively being used to allow short-term creditors to exit loss-free. As a result, there was not enough money left over to help soften budget cuts necessitated by the sudden stop in foreign funding.

The experience of the recent eurozone crisis stands in sharp contrast to the Latin American debt crisis in the 1980s, when banks were not allowed to exit precipitously from their loans. If the new proposal is adopted, the IMF would conditionally refuse funds to countries carrying debt burdens that Fund staff determine are most likely unsustainable; creditors would first have to agree to a “reprofiling” of debt.

Reprofiling is a euphemism for debt restructuring, which allows countries to borrow from existing creditors for longer periods and at lower interest rates than they would be able to do on the open market. Although it is far from clear how easily the IMF could hold the line against hard-bargaining creditors, the new policy, if adopted, would toughen the Fund’s approach to cases where it finds itself repeatedly throwing good money after bad.

At present, the United States seems reluctant to go along with the IMF’s proposal. Evidently, US authorities believe that in some situations geopolitics trump economics (reflected, for example, in the IMF’s recent re-entry into Ukraine after a string of failed programs).

This American resistance is unfortunate. It would be far better if the US found ways simply to organize outright grants in exceptional cases like Ukraine, rather than design the international financial system around them.

Given the recurring complications of adjudicating sovereign-debt contracts in foreign courts, and the world’s inability to organize a credible and fair procedure for foreign bankruptcies, perhaps the best idea is to steer the bulk of international debt flows through debtor-country courts. Jeremy Bulow and I made a proposal along these lines 25 years ago; it is still the right approach.

In this scenario, countries interested in borrowing large amounts from abroad would need to develop institutions that made the promise to repay credible. By and large, experience supports this method. Indeed, the huge expansion in emerging-market domestic-debt issuance in recent years has helped reduce market tensions (though continuing reliance by corporates on foreign debt still leaves many countries vulnerable).

But domestic borrowing is not a panacea. To believe that any country issuing debt in its own currency is risk-free as long as the exchange rate is flexible is astonishingly naive. For one thing, there is still inflation risk, particularly for countries with weak fiscal institutions and heavy debt burdens.

Nonetheless, Argentina’s latest debt trauma shows that the global system for sovereign-debt workouts remains badly in need of repair. Deepening domestic debt markets – and perhaps change along the lines proposed by the IMF – is sorely needed.

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    1. CommentedFelipe Manteiga

      Balanced analysis. Ukraine was, is and will be thoroughly corrupt. And so is Argentina. Unfortunately, many senior executives in leading "global" banks , who are keenly aware of these faults in the soverign persona, eagerly lend resources not only for the benefit of the official interest rate charged, but also for the informal (or rent seeking) fees collected.

      Af fat as the U.S. policies are concerned, many worry about by the vice copacetic interests in FED, Treasury, and Wall St. are tightening on all financial markets. This structured scarcity should reward generously rent seeking fees by bank executives.

      The young will go jobless, but bankers will sing their way to ....the bank.

    2. CommentedEmilio Perez

      with emerging powerful markets coming up, the US should stop imposing these usurious practices and create fair lending practices.

    3. CommentedJose Oyola

      The Rogoff piece describes a sound policy that should be pursued by IMF and other multilateral lending institutions, namely, outright grants to countries in two circumstances:
      (a) Humanitarian aid in response to a significant destruction of the productive capacity due to acts of nature (e.g., Haiti)
      (b) Geopolitical purposes (e.g., Ukraine).
      Why Ukraine, who is an insolvent country with chronic budget deficits and is facing the imminent danger of an invasion by Russia, given a "loan" instead of a grant?

    4. CommentedRoger Lerner

      There needs to be a recognized forum for restructuring debt of sovereign debtors, which applies a uniform body of law/standards. Sovereign nations cannot be forced to pay, short of war, or cut off from credit markets, neither of which is happens
      Those who buy US corporate debt know what can be done via. the US Bankruptcy Code. We need a similar set of standards, uniformly enforced by compact among sovereign borrowers and lenders, adjudicated in a neutral forum. This allows predictability, better pricing and some level of insulation from local political demands for abrogation. In the end, it certainly will not be perfect as governments seem to have a limitless thirst for borrowing and lenders and unrelenting willingness to satisfy that thirst. Present greed seems almost always to trump experience.

    5. CommentedJohn Gavin

      Isn't it a mistake to allow nations that have demonstrated repeatedly their incompetent management of their own money supplies?
      Why should we be lending to these countries at all before they demonstrate political changes that address the corrupt use of the borrowed funds by these regimes? The IMF and nations who continue to lend while ignoring the corrupt theft of loans intended to benefit the people in these nations must understand that such circumstances only exacerbate the problem and strengthen the corruption by making it profitable. Why do we give handouts first and whine about their misuse by government after the funds have been stolen?

    6. CommentedChristopher Goodwin

      "A great opportunity for re-engineering the law.. governing sovereign debts." (Pitikaris) "Unsettling questions for policymakers" (Rogoff)
      "another approach to debt rescheduling" (the IMF) So now "reprofiling."
      ARE YOU NOT ALL MAD? These are alternative ways of saying, "We want to be able to borrow money, and not pay it back, that would be just cute." The only workable solution is to say, "We cannot pay" with the obvious "We will not lend you any more." EOTWAWKI. And a good job, too. The World as we know it is run on systematic crime. Stop now.

    7. CommentedTerrence Moloney

      Reprofiling only works if it's negotiated for in accordance with the terms of the notes. It's not really a function of whether the US is reluctant or enthusiastic. It's up to the market under what terms it is willing to lend: will it lend if the notes provide for a subsequent reprofiling with majority consent of note holders or not? I can't see how the IMF refusing to lend money to a sovereign in trouble unless third party creditors agree to profiling is going to accomplish much unless the third party creditors are offered something in return. In essence this means the IMF would be negotiating a restructuring with the creditors and there could still be holdouts, depending on terms of the notes.

      It also doesn't seem likely the markets would accept borrower courts. Very risky since so many of the courts have weaker judicial independence. The premium would increase considerably. Nor is it obvious that the results of such adjudication would be any less controversial; someone's going to lose.

      Lastly, which governing law countries and their investors agree to doesn't have much to do with what currency you borrow in. You can agree to borrow Yen but have a NY-law governed contract.

      I think on the whole Professor Rogoff overestimates policymakers borrow here: how would they steer international debt flows through the borrower's courts, for example? These are private contracts. Mess around and you'll just make rates higher or borrowing impossible.


    8. CommentedSam Iam

      What happens in emerging markets which don't have well established bankruptcy laws and lots of cronyism? Why are debtor countries bankruptcy laws most apt to adjudicate bankruptcy? Is there a risk to the international financial system?

    9. CommentedTheodoros Pitikaris

      The question is whether or not Argentina was able to pay in full one or some creditors due to Rights Upon Future Offers (RUFO) clause
      If the Argentina was in European Union the holders would never get paid since CACs are in place.

      One the other hand Argentina had deposit on time the money to the Bank of New York Mellon, on interest rate coupon repayment due to 31st of July. But the Judge following the law gave a specific and clear order to Argentina to pay the two funds in full before any other creditor.

      A tear for Argentina, a tear for the western civilization or a a great opportunity for re-engineering the law that governing the sovereign debts. An great opportunity for rebooting the whole market.

        CommentedSiegfried Eschen

        The deposit has no value since the contract says, that the money has to be available for the creditors. In this case the judge had prohibited the payment, because no payments had been ordered to the holdouts. If the bank had transferred the money to the 92% of creditors only, it could have lost its license. Argentina knew this, but transferred the money to the bank nevertheless. This shows the problem in a nutshell: if the sovereign operates as if it stands above the law, creditors have a hard time. In the good old days, these kinds of sovereigns just decapitated those nasty creditors! So no tears at all for Argentina! The people get the government they deserve. Hard times are coming for the next generations of Argentines due to these populist governments. Of course, the Kirchners themselves became very rich during their stay in public functions, whereas 30-40% of the Argentine people are poor now (if the scientific data are correct and less cooked up, than the official ones).