As if Argentina did not have enough of a vulture fund-induced headache with the Frigate Libertad held up in Ghana, a November ruling by US judge Thomas Griesa in favour of these funds put the country on the brink of a debt default. The ruling was later overturned, but the heart of the matter -whether Argentina has to pay to the vulture funds and what would be the international consequences if it does- remains to be decided.

The Debt Swap

After a long cycle of indebtedness that started out during the last military dictatorship (1976-1983) and increased exponentially in the 1990s, Argentina defaulted on its sovereign debt in December 2001, in the middle of a massive economic and political crisis. It was considered the largest sovereign debt default in history.

Néstor Kirchner succeeded Eduardo Duhalde as president and inherited the defaulted debt.

In 2005, the then-president Néstor Kirchner annouced the beginning of a debt restructuring process, offering bondholders to swap their defaulted bonds for new ones of lower value, lower interest rates, and/or longer payment terms. This way, Argentina managed to renegotiate just over 75% of its debt.

In February of that year, and as a way to encourage investors to enter the debt swap, Congress passed a bill commonly referred to as ‘lock law’. This law prevents the government from starting up a new debt exchange process in the future, and also establishes that the defaulted bonds cannot be subject to any kind of judicial arrangement.

The ‘lock law’, however, was temporarily suspended in 2010 to allow for a new swap, and finally 92% of the defaulted debt was exchanged. The majority of the remaining bonds are in the hands of vulture funds, whose strategy is to buy defaulted bonds at rock-bottom prices and then litigate to have them paid at their nominal prices.

This is what NML Capital, Elliott Associates, and other such investment companies did. When the debt was originally issued, it was placed under the jurisdiction of the US judicial system, in a move to make the bonds safer and more attractive to investors. This is why the litigation is being carried out under the watch of judge Thomas Griesa of the second district court of New York.

The Ruling

Griesa’s latest ruling was a response to a request put forward by the Court of Appeals in November.

In February, Griesa had ruled on a case put forward by NML Capital (the same company involved in the Frigate Libertad affair), a hedge fund that owns defaulted Argentine debt, and which refused to take part in the 2005 and 2010 debt swaps. In that ruling, Griesa stated that Argentina must pay NML in full, and with interests, for the bonds it owns.

The ruling was based on a controversial interpretation of the legal concept of pari passu (Latin for ‘equal footing’). The judge interpreted it as meaning that when a country pays its restructured debt, it must also pay the total amount that is owed to the holdouts (those who did not enter the swap).

The sentence was appealed by Argentina, and on 26th October the Court of Appeals upheld the original verdict, but requested clarification on some matters regarding the implementation of the court order before issuing a final ruling.

In his response, considered unusually harsh by some analysts, Griesa stated that recent public declarations by President Cristina Fernández de Kirchner and Economy Minister Hernán Lorenzino regarding their refusal to pay the vulture funds constituted a violation of his February ruling. The ruling states that “Argentina is prohibited, during the appeal, from taking any action to evade” the payment.

Economy Minister Hernán Lorenzino defied judge Griesa's ruling (photo courtesy of Economy Ministry)

Based on these declarations, on 21st November Griesa ruled that “(t)he less time Argentina is given to devise means for evasion, the more assurance there is against such evasion”, and ordered the country to pay US$1.33bn -the amount owned to NML and other vulture funds- into an escrow account to guarantee that if the Court of Appeals upheld his ruling, Argentina would not be able to evade the payment.

Griesa also tied up the payment to the vulture funds to Argentina’s payment to the exchange bondholders which was due on 15th December. This means that he instructed the intermediary bank (Bank of New York, or BNY) to not pay the exchange bondholders on 15th December unless Argentina deposited the US$1.33bn. This way, the choices for Argentina would have been to either pay everyone (including the vulture funds) or no one, thus defaulting on its debt to the exchange bondholders.

Argentina’s Response

Advised by their US law firm, the Argentine government acted swiftly and sent a letter to the Court of Appeals on 26th November, the first working day after Griesa’s ruling. In it, they requested the court to grant a stay and maintain the status quo until the appeal process is complete, to “avoid irreparable harm to [Argentina] and numerous third parties.” The appeal process could go as far as the US Supreme Court, though there are doubts as to whether the Court would take the case.

On 28th November, the Court of Appeals ruled in favour of Argentina dismissing Griesa’s order and maintaining the stay until they reach a conclusion on the case. They set up a series of dates in which Argentina, the vulture funds, and interested third parties (such as the exchange bondholders) will have to file their papers, and scheduled a hearing on 27th February.

The letter submitted by Argentina also stated that a possible “remedy” to the situation would be if the court offered the vulture funds the same terms that Argentina offered holdouts in the 2010 exchange offer. “Under Argentine law, the Argentine Executive could present that proposal to Congress, but it cannot present a proposal that treats some creditors better than others, and it cannot fund an escrow.”

This has been seen as an indication that the government is willing to temporarily suspend the ‘lock law’ again, in order to re-open the exchange process and include the vulture funds. Its legal team hopes that the Court of Appeals will take note of the suggestion. So far, various opposition politicians have indicated their support for this alternative, and have said they would vote to amend the ‘lock law’ in Congress.

The Consequences

The case has caused international uproar, as the consequences of Griesa’s rulings could have, according to analysts, shaken the foundations of the financial system.

Wall Street, the heart of the financial world (photo by Momo)

On one hand, Griesa’s November ruling put the BNY in a difficult position. As the bank acts on behalf of the exchange bondholders -not on behalf of Argentina- not paying them if Argentina decided not to pay the vulture funds would have put it in a breach of contract with its clients. The bank complained about this on a brief to the court, saying that they “should not be forced by Argentina’s independent violation of the Injunction to choose between exposing itself to the risk of contempt, on the one hand, or the risk of claims from Exchange Holders for breach of the Indenture, on the other.”

The Federal Reserve Bank of New York, the Clearing House Association, and the Depository House Company, all alarmed by the situation and its potential impact on financial markets, wrote to Griesa supporting the BNY’s position and requesting that “any order issued by the Court should be crafted not to apply to beneficiary’s banks, funds-transfer systems, or other parties in a funds transfer,” as this “could have operational ramifications that impede the smooth and efficient operation of the payments system.” They were concerned about the potential effects on investors’ confidence in the market -and in finance, confidence is everything.

But the main issue is still the judge’s interpretation of the pari passu clause and the order to pay the holdouts in full despite their refusal to accept a debt swap -twice- which casts doubts on the future of sovereign debt restructuring everywhere. Who will accept a massive reduction in the price of their bonds and longer payment terms, when they know they can obtain a favourable court ruling, such a Griesa’s, and get the full amount? How will countries face a default in debt payments under these circumstances?

A recent editorial on the Financial Times put it clearly: “Trapping countries in unpayable debt obligations is dangerous. While countries should service their debts in all but exceptional cases, an orderly mechanism for sovereign restructuring is essential for the exceptions.” This is particularly relevant at the moment, as many EU countries face the possibility of having to restructure their debts, Greece being the most urgent example.

Griesa’s ruling was a close call for Argentina, and speculation ran rampant as to what the country would have done if the Court of Appeals had sided with Griesa. However, the 28th November ruling only buys the country time to try and convince the Court to find a reasonable conclusion to the matter -such as reopening the 2010 exchange.

It is not clear whether the Court of Appeals will accept this suggestion, or uphold Griesa’s interpretation of the pari passu, but it is certain that there is much more at stake than Argentina’s claim. The world is watching.

A US court in New York ruled late last night that Argentina must pay US$1.3 billion to hedge funds that refused to restructure their debts after the South American country defaulted in 2001. The debts must be paid by December 15^th.

The US district judge, Thomas Griesa, rejected Argentina’s appeal to halt payments to bondholders who refused to participate in debt restructuring programmes following the 2001 default.

The ruling raises the possibility that Argentina may default once again. If upheld, it also illustrates that countries do not have as much sovereign immunity from creditors as is often perceived.

The court order is the latest development in a case that has run for 10 years and is not over yet. It will now return to the US 2nd circuit court of appeals, where officials will assess the judgement.  The hedge funds are led by Elliott Management Corp’s NML Capital Ltd, an aggressive fund that has a reputation for suing countries.

“It is hardly an injustice to have legal rulings which, at long last, mean that Argentina must pay the debts which it owes,” said Judge Griesa. “After 10 years of litigation this is a just result”.

Argentina has previously refused to pay the debts, claiming that the funds were “vultures” and “scavengers”.

Judge Griesa also confirmed that third parties will be affected by the ruling, placing an injunction on not just Argentina, but also “other persons who are in active  participation with the parties or their agents”.

The judgement rules that Argentina must pay almost immediately. The order states “the less time Argentina is given to devise means for evasion, the more assurance there is against such evasion”.

President Cristina Fernández de Kirchner has renegotiated with the Paris Club to pay back the nations defaulted debt without the aid of the IMF.

Argentina owes US$6.7 billion to the Paris club, a collection of 19 countries who offer financial advice and assistance with debt restructuring to nations with struggling economies. The informal organization was set up 54 years ago to aid Argentina, specifically. This payment, including US$1.1 billion in interest, marks Argentina’s final exit from a default state. The money will be paid back in installments, starting in 2011, without audits from the IMF.

“We know what the intervention of the IMF meant for our country, and in truth it was very bad for our nation, and this was understood by the Paris Club,” held Argentine Economy Minister, Amado Boudou after announcing the agreement.

Boudou announced the “payment plan will commensurate with the growth of Argentina.” He added that the debt repayment will “will free up the possibility of soft loans to Argentina, marking “the final departure from default.”

The final agreement with the European debtors was reached at the G20 summit in Seoul, South Korea, yesterday. The first round of meetings stipulated a five-year period of payment, but it has since been announced that the debt will be cancelled by 2013.

Boudou announced that the positive response from the Paris Club was a “triumph of international politics” and “a recognition that Argentina has become credible and reliable.”

In a broadcast on national news, President Fernández said “we’ve generated confidence in Argentina’s commitments, and if God helps us, we will fully recover from default next year. It took us ten years to agree this. A government that only lasted one week took us to default. This shows how easy it is to destroy and how hard it is to rebuild.”

When Argentina and Greece meet in the final Group B game of the World Cup on Tuesday, the European players might be asking for more than a change of shirts with Maradona’s men. For when their stay in South Africa comes to an end, the Greek team will return to a country mired in a debt crisis the likes of which haven’t been seen since 2001… in Argentina.

Photos by adisfansnet

Greece vs Argentina at 2010 World Cup

Nine years ago, Argentina was in the middle of a deep recession, with a government that was scrambling to make payments on its ballooning debt and struggling to contain widespread social unrest. Since the Greek government revealed the true horror of its financial position late last year, the parallels have been obvious. In both cases, years of irresponsible borrowing, combined with economic mismanagement and an inflexible exchange rate system caused a build up of pressures that would bring each country, as Greek president Karolos Papoulias admitted in May, “to the edge of the abyss”.

Argentina: The Biggest Default in History

On 21st December 2001, embattled president Fernando de la Rúa resigned amid mass public protests, abandoning the Casa Rosada by helicopter so as to avoid the riots in the streets outside. In the two weeks that followed, Argentina would see four new presidents, formally default on a large part of its US$132bn debt, and implement a mega-devaluation of the peso. The social consequences were nothing short of catastrophic: inflation soared to over 40%, unemployment rose to over 20%, and soon over half the population were living below the poverty line.

Photos by SUB

Argentina riots on 9 de Julio during the financial and governmental meltdown of 2001

This spectacular collapse sent shockwaves through international financial markets, but the problems that led up to default began a long time earlier. The Argentine economy was in decline from the end of 1998, hit by successive financial crises in Asia (1997) and Brazil (1999). Meanwhile, the ‘Convertibility Law’, which tied the peso at 1:1 with the US dollar was hurting local producers and exporters, who struggled to compete using an increasingly overvalued currency. A series of interest rate hikes in the US also made government borrowing to plug the external deficit progressively more expensive, leading to a rapid build up of debt.

As the recession reduced the government’s capacity to service its debt, confidence began to waver: investors fled the country, followed closely by any individuals who were able to move their savings abroad. By late 2001, with the Central Bank’s reserves almost dried up, it was clear that De la Rúa’s government was running out of options for keeping the Argentine economy from total collapse. The only source of finance left was the IMF, but these loans were conditional on the government’s implementing deeply unpopular austerity measures that would deepen the recession further and aggravate social tensions. When the desperate government froze bank deposits in a last ditch attempt to stem the outflow of money, its fate, and that of the economy, was all but sealed.

Greece: The Biggest Default in History?

Photos by endiaferon

Greecians march in protest in 2010 over the austerity measures put in place on the country

The situation in Greece today bears many of the hallmarks of the slow-motion crash that Argentina suffered. It is the Athenian government who faces the impossible task of trying to service its huge debt while also steering the economy through a deep recession, who last month was forced to appeal for financial assistance (from a combination of the EU and the IMF), and who now must convince the public to swallow painful spending cuts and tax hikes for at least the next three years.

Will the end result be the same? Prime Minister George Papandreou and his cabinet are relentlessly upbeat, dismissing talk of a default as the work of ‘irresponsible media’ and reassuring investors that the country is slowly finding the way back to fiscal discipline and growth. But anyone who saw the images of Athens in flames during riots last month will wonder how long the government will be able to squeeze the economy in the face of public outrage.

Some economists don’t even think they should try. EU financial assistance will give the country some breathing room, but it will not solve the debt problem, and the magnitude of the fiscal adjustment and structural reforms required is such that it could take many years for the Greek economy just to return to its pre-crisis levels. And that’s a best-case scenario.

Mark Weisbrot, co-director of the Washington-based Center for Economic Policy and Research (CEPR), wrote in the New York Times last month: “no government should sign an agreement that guarantees an open-ended recession, and leaves it to the world economy to eventually pull them out of it. This process of “internal devaluation” — whereby unemployment is deliberately driven to high levels in order to drive down wages and prices while keeping the nominal exchange rate fixed — is not only unjust, it is unviable.”

Weisbrot’s comments capture the lingering sentiment here in Argentina, where the IMF is still vilified for its involvement in the crisis. One creative company even created a board game loosely based on Monopoly called ‘Deuda Eterna’ (Eternal Debt), in which players must try to build up industries without falling afoul of the IMF’s punitive lending conditions.

No Easy Way Out

Photos by George Laoutaris

Greek Riot police stands in front of a protesting crowd

In Argentina, several years of painful budget tightening only served to delay the inevitable. In spite of the giant EU bailout, three-quarters of investors and analysts polled by Bloomberg recently believe Greece will still be forced to restructure some or all of its debt. Almost half think it will abandon the euro altogether, with the devaluation providing a boost to exporters that should kick start a broader economic recovery, as was the case for Argentina from 2003. However, exiting the Eurozone and introducing a new currency would be devastating for Greece in the short term, and hugely destabilising for the whole region.

In short, the few options still available to Greece from this point are almost universally bleak. With the immediate threat of bankruptcy diminished by the EU bailout, events in South Africa could provide a welcome distraction from reality. In 2002, as Argentina reeled from its financial meltdown, its national team crashed out of that summer’s World Cup in the group stages. On Tuesday, the whole of Greece will be praying that, on the football pitch at least, history won’t be repeating itself.

Argentina will have a budget deficit for the first time since 2002 which will increase the possibility of default as stagnating tax revenues fail to meet spending demands, writes Morgan Stanley economist Daniel Volberg in a recent report.

According the Volberg, the government of Cristina Fernández de Kirchner will fall US$3b short of its scheduled US$19b debt payment for 2010. Volberg predicts a deficit of 0.6 per cent in 2009 and 0.9 per cent in 2010. He added that “the worst of the fiscal deterioration may still be ahead.”

“With a deteriorating fiscal position, investor concerns about Argentina’s ability to honour its debt obligations may intensify,” he said.

In efforts to bolster her government’s image, President de Kirchner had increased spending leading up to midterm elections last moths. Government spending increased 33 per cent this May over the same month last year, while revenue fell 3.1 per cent.

In June the primary surplus, a measurement of the government’s extra cash before debt payments, fell to $915m from $2.65b in June 2008.

According to the Financial Times experts say Argentina’s economy is even more depressed than some believe. The newspaper reports that GDP may shrink by as much as 2 to 3 per cent this year, a much more dismal projection than the government’s 1.88 per cent for a year from May.

Fears that the government economic statistics agency Indec has been massaging numbers may be causing investor flight, with the local consultant group Econoviews reporting as much as a US$6.5b second quarter flight of capital from the country, according to the Financial Times.

“There are too few observations to be sure that the worst of the recession is over. The problem is compounded by the lack of credible macro data,” Carola Sandy, Latin American analyst at Credit Suisse told that paper.

All this is stoking fears that Argentina will default on its debt for the second time in ten years. The first was in late 2001, and the country has been shut out of international markets since.

President de Kirchner’s controversial moves to try to tax agricultural exports and nationalize private pension funds have both been seen as grabs for cash to try to pay down the county’s remaining dept