Argentina Ruling: Bad Precedent for Debt Crises?

cristina fernandez de kirchner

The United States and Argentina rarely find themselves on the same side of finance or trade disputes, but the governments of both countries agree that a recent court ruling could set a dangerous precedent for debt restructurings.


In a long-running court battle between Argentina and holdouts who refused to accept debt exchanges following the country’s default in 2001, a U.S. federal judge sent shockwaves across debt markets in November by issuing a broad ruling in favor of the bondholders. U.S. District Judge Thomas Griesa said that if Argentina doesn’t pay the holdouts the full $1.3 billion being claimed, other entities involved in the payments – from the trustee of the Bank of New York Mellon to global clearinghouses – would also be in violation of the court order.


The U.S. and Argentina warn that the ruling, which has been stayed by the U.S. Appeals Court until all parties now involved can argue their cases, could convince more bondholders to hold out from debt restructurings in the future.


The U.S. and others are concerned that at a time of ongoing instability in sovereign debt markets, especially in Europe, the ruling could make future negotiations over debt terms difficult.


Washington’s decision to side with Buenos Aires is unusual, given the growing animosity between the two governments over Argentina’s nationalization of oil company YPF last year and its increasingly restrictive trade policies.


In a brief filed in the case in late December, the U.S. Attorney General’s office said if enough creditors adopt the same strategy of using new interpretations of bond provisions to hold out, “foreign sovereign debt restructuring will become impossible.”


The U.S. brief says that it “does not condone Argentina’s actions in the international financial arena,” but said the impact of the ruling could spread “well beyond Argentina” given the increase in creditor litigation.


But some finance experts polled by The Financialist dismiss the prospect that Judge Griesa’s ruling could thwart efforts to contain the European debt crisis or future debt restructurings, saying the U.S. ruling would likely only serve as precedent for cases involving debt issued in Argentina.


“I think that’s just an Argentina event,” William Cline, senior fellow at the Peterson Institute for International Economics, told The Financialist.


Most new bond issues, Cline noted, contain collective action clauses that bind all creditors to a restructuring if some specified majority agree to the terms.


“You’re talking about old paper, it’s just not going to be that much debt at stake for the U.S. to worry about that with respect to Europe,” said Cline, a former U.S. Treasury official. “The decision is a precedent in its context – it would apply to countries that have really stiffed creditors for a long period of time.”


Cline recently took part in a debate over the potential fallout from the Argentina ruling last week with Anna Gelpern, another former Treasury official who is a visiting fellow at the Washington-based think tank.


She argued that if the ruling stands, it would “revolutionize” debt restructurings “by the shear breadth of the collateral damage it could inflict on the financial system.”


“I don’t know to what extent anybody will or wants to blow up the world,” said Gelpern, adding that if the ruling does stand, trustees may not want to participate in future restructurings if there is a liability risk.


Cline said collective action clauses should limit the power of holdouts, noting that Greece was able to retroactively include such provisions in its bonds during last year’s debt restructuring.


Still, the U.S. argued in its brief that some holdouts in the recent Greek debt exchange were able to block amendments despite collective action clauses.


While acknowledging that such provisions diminish the prospect of a holdout disrupting a bond restructuring, the U.S. said most bonds issued under New York law before 2005 lack collective auction clauses — and many will likely remain in the market for the foreseeable future.


Unless the court’s order is amended, a potential refusal by Argentina to pay the holdouts could trigger a cross-default in billions of dollars of debt that was voluntarily exchanged with investors.  Such a possibility would create yet another headwind for an Argentine economy facing stagflation, partially driven by a collapse in foreign investment due to restrictive policies, said Casey Reckman, vice president in Latin America economic research at Credit Suisse.


“We expect investor nervousness about the timing and outcome of the final result of the legal process, which may still include an appeal to the U.S. Supreme Court, to increase in the coming months,” she wrote in a bulletin this month.


While Reckman said the odds of a more favorable ruling from the Appeals Court have increased due to support for Argentina from the U.S. and others, the Argentine government may still refuse to pay the holdouts. Since the Appeals Court has already endorsed the judge’s ruling that holdouts should be treated equally to other bondholders, she expects future decisions to focus on how much should be paid and whether third parties should be involved.


Photo of Argentine President Cristina Fernandez de Kirchner welcoming back the ARA Libertad after it was held up in Ghana in an effort to force repayment of Argentine debts courtesy of the President’s Facebook page.