Something slightly strange will happen at the US Supreme Court today. It’s the deadline for amicus briefs in support of Argentina’s request to overturn lower court rulings that would force the country to service parts of the debt on which it defaulted in 2001. The strange thing is that governments to which Argentina owes money—and which are deeply frustrated with the country’s scofflaw ways—are likely to be among those filing briefs in its support.
They have good reason. If the Supreme Court rules against Argentina, it will effectively undo the settled conventions by which we restructure the debts of financially-distressed sovereigns. Every sovereign-debt restructuring negotiated in the past decade could be reopened.
Argentina’s $130 billion default was massive. It covered nearly 15% of all emerging-market debt then outstanding. Foreign-law bonds made up about $80 billion of the debt that went into default; those bonds issued under New York law are the focus of the current US proceedings.
At present, countries, unlike people and corporations, lack a bankruptcy system that would let them start with a clean slate if they can’t pay their obligations. A decade ago, the International Monetary Fund (IMF) tried to build a Sovereign Debt Restructuring Mechanism (SDRM) into its operations—prompted in part by wrangling over Argentina’s default. In 2003, the SDRM was rejected as various countries were unwilling to cede the sovereignty necessary to make the SDRM work.
Left to its own devices, Argentina pursued an aggressive strategy to force its bondholders to concede to massive write-offs. In successive 2005 and 2010 debt swaps, Argentina offered foreign bondholders a two-thirds “haircut” (loss) on their impaired debt. Most of them eventually accepted, knowing that the likely alternative was to get nothing. A minority, however, representing about 7% of the defaulted debt—including thousands of Italian retail investors and a smattering of hedge funds—refused to participate in the swaps and have instead pursued full payment of their bonds.
The alternative to a haircut is a bloodbath
The main tactic of these “holdout” bondholders has been to pursue US court judgments that would support seizure of Argentine sovereign assets outside the country. The Argentine government has been forced into some quirky responses. President Cristina Fernández de Kirchner, for example, avoids flying abroad on Argentine-owned jets because of the risk that they might be impounded, and in 2012, Argentina was forced to fight a temporary hold on its navy tall ship, the Libertad, that was docked in Ghana.
Today’s deadline, however, pertains to something different: a series of lower-court rulings that found that Argentina is violating the pari passu—Latin for “equal footing” or treatment—clauses in its defaulted bonds by making debt-service payments to the creditors that participated in the 2005 and 2010 restructurings. This in the US courts’ bailiwick because the bonds still in default were issued under New York law and the debt service on the restructured bonds passes through payment systems in New York.
The reason this matters is that, in the absence of a sovereign bankruptcy system, exerting pressure on creditors to accept a haircut is the only way a country can deal with a debt load it can’t pay. If the Supreme Court upholds the lower courts’ rulings against Argentina, all countries will lose that leverage. The balance of power will be tipped strongly away from debtors toward their creditors; there will be little incentive for creditors to negotiate with troubled sovereigns. No wonder, then, that even governments to which Argentina owes money are expected to support its case.
Meanwhile, Argentina continues to play hardball. It announced last year that it would offer to swap its restructured New York-law bonds into domestic Argentine debt to move the related payment stream beyond the purview of US courts.
There are better ways to address this situation. First, New York should pass laws to immunize its payments systems from attempts by holdout creditors to seize debt service on already restructured bonds. There’s good precedent for such action: Belgium immunized its Euroclear payments system around the turn of the century in response to a case against Peru; and Britain created walls in London a decade ago to stop similar actions by creditors against heavily-indebted poor countries.
Second, we need to help governments resolve their debt problems in a more proactive and consensual fashion. The investors pursuing Argentina have repeatedly indicated that they’re ready to negotiate with the country’s authorities. Let’s take them at their word. With Richard Gitlin, I’ve proposed the creation of a Sovereign Debt Forum (SDF) to provide a structured venue for these conversations.
After years of deficit spending to combat the 2008 global financial crisis and ensuing Great Recession, governments across the world are now heavily indebted. More debt crises are coming, and we can’t afford a repeat of the Argentine saga. Regardless of what the US Supreme Court decides in the coming months, Argentina should be a prompt to make our approach to sovereign debt restructuring more robust.
Brett House is a Senior Fellow at The Centre for International Governance Innovation (CIGI) and the Jeanne Sauvé Foundation at McGill University. He is also a Chazen Visiting Scholar at Columbia Business School.