Argentina versus the Vultures – simple solution but leave morality out of it

There are several petitions circulating around the Internet at present condeming the US Supreme Court’s decision on June 17, 2014 to reject the appeal by the Argentine government against a prior US court ruling in favour of NML Capital Ltd, which effectively denies the Government access to the US banking system until it repays the outstanding liabilities that NML holds. The implication of the decision is that the Government can no longer service any liabilities is has which require payments being made via the US banks. That means the vast majority of the so-called ‘exchange’ bond holders, who took settlements in 2005 and 2010 after Argentina defaulted on its public debt obligations, cannot be paid until NML, who has a small amount of so-called ‘hold out’ Argentine government debt, is paid in full. What can the Argentine government do in this situation, given it has been fully servicing the exchange liabilities but claims it cannot meet the original liabilities held by NML? The answer is simple and doesn’t involve putting advertisements in US newspapers pleading the fairness of the situation. There is no sense of fairness involved.

NML is a so-called vulture fund or as the petition E-mail tells me, represents a “small rogue group of hold-out shareholders who reject a debt reconstruction deal concluded after year of patient negotiation”.

The E-mail also informed me that the US Supreme Court decision has “has profound implications for the financial system as well as the management of sovereign debt and the fate of many newly-indebted nations including Greece and Portugal.”

I guess the word ‘informed’ was poorly chosen by me in this context. Misinformed is a better description. There are no negative implications for Greece and Portugal of what is going on with Argentina given that the former duo uses a foreign currency (the euro) and Argentina is sovereign in its own currency, and therefore has opportunities available to it that neither Greece or Portugal have under their current membership of the EMU.

The only parallel is that Argentina has shown other beleaguered nations such as Greece and Portugal what a country that is locked into currency arrangements that prevent the national government from acting in the best interests of its own people can do if they have sufficient courage.

In other words, when Argentina defied the IMF and the hedge funds in 2002 and defaulted on its liabilities and broke the currency peg with the US dollar, it was acting like a nation that is sovereign in its own currency. Greece and Portugal should take heed of that example and exit the euro-zone as soon as possible to escape the stifling stagnation that EMU membership has delivered.

Further, the US Supreme Court decision really undermines any hope that the vulture funds have of reaping profits on their bargain-basement buying of distressed public debt although one wouldn’t gain that impression by reading the wording of the petition and many of the press reports that followed the decision. I will come back to that point presently.

One petition I received in the last week from a progressive group claims that:

Finally, the Supreme Court claims to have acted in the interests of preserving New York’s status as a major capital market.

Sometimes, progressive rhetoric gets ahead of itself. The wording of the Supreme Court decision – Republic of Argentina v. NML Capital, Ltd. – tells me that they were operating consistently according to the legal framework they are bound by.

I actually wonder how many journalists and progressives etc who are now claiming the vultures are at the bottom end of the moral ladder have read the decision.

The Court was ruling as to whether there is foreign sovereign immunity in this matter under the terms set out in the US Foreign Sovereign Immunities Act of 1976 (FSIA) to limit the “the scope of discovery available to a judgment creditor in a federal postjudgment execution proceeding against a foreign sovereign”.

That is, Argentina wanted the process via which NML sought to “discover” (locate) other Argentine assets, which could be seized, stopped. Specifically, NML wanted access to documents held by the Bank of America, after they worked out that Argentina was using the bank to channel funds.

The US District Court refused to cancel the subpoena, which compelled the Bank to provide NML with the information sought. The Court ruled that this action within the US (“the extraterritoral asset discovery”) “did not offend Argentina’s sovereign immunity”.

Argentina appealed that decision and the US Supreme Court threw the appeal out last week. I will leave it to the lawyers to debate the finer points of the decision in relation to the legislative code that constrained it. There was one dissenting judge.

Lets clear up another matter. The petitions are being circulated by so-called progressive groups and the language in the E-mails exhorting the recipient to sign up and express outrage at these vulture funds, which are constructed as preying on defenseless nations and prevent Argentina from having good-standing in international public debt markets.

The appeals for signatures are laced with moral overtones about fairness and equity. Apparently, these vulture funds are predators who have no rights under the rule of law and the Argentinean government is an honest, debt-repaying nation that just wants to be fair to the majority of its creditors.

I cannot see any morality in any of this – on any side. The stupid Argentine government borrowed in foreign currencies and was in league with the disastrous IMF in the 1990s to shackle their citizens in arrangements that were always going to crash.

They had solicited funds, which were provided from a host of creditors acting in good faith and expecting the rule of law to apply, as it does in all contractual arrangements. The Government clearly held out that it would repay the debt and service the interest obligations along the way.

They defaulted. Hardly a very ‘honest’ thing to do. But it was the only thing they could do given the crazy decisions of the regime that got them into the mess in the first place. Sure, they were probably seduced by flash marketing schemes common in products being offered by ‘Wall Street’.

Sure, the political leaders probably enjoyed mixing with IMF officials at swank hotels with sumptuous dinners and good wine flowing freely. But, the fact remains – they defaulted on their obligations and there is no moral higher ground for the Argentine government to take in this matter. They are not defenseless nor in need of our sympathy.

The big banks and hedge funds who loaned the Argentine government the cash were presumably using appropriate risk-management techniques to judge the risk-return calculus of their financial investment. Eyes presumably were open and big commissions paid to brokers etc. They are not defenceless nor in need of our sympathy.

The small group of creditors who would not agree to the massive discount that was required by the Argentine government in the default negotiations had their eyes opened too. They decided, for whatever reason, that they would not settle just to get some cash instead of no cash from their prior bond purchases. They are not defenseless nor in need of our sympathy.

The so-called vulture funds, including NML Capital didn’t break any laws but realised that the small group would accept a certain settlement for their bonds. The vultures knew that the Argentine government had made some stupid errors in offering the ‘exchange’ bonds (for example, rendering payments in US dollars through the US banking system) and therefore had some leverage through the legal system.

They are not evil just rapacious financial capitalists acting to form – totally within the law but involved in a high risk strategy, which could deliver nought. Risk and return. They are not defenseless nor in need of our sympathy.

I cannot see any immorality in NMLs decision to refuse to swap its old (defaulted) bonds for the new heavily deprecated assets that the Argentine government offered. The fact that the vast majority of bond holders agreed to the deal doesn’t alter any of the rights of the minority, even if that minority was a single person or investment firm.

Some brief history. In 2005 and again in 2010 (as debt became due for repayment), the Argentine government persuaded the vast majority of its bondholders to exchange them for new bonds, which were discounted by 70 per cent. Since then the Government has been servicing the exchange bonds without issue.

The exchange-type solution to a default arises because there are no formal rules governing sovereign default. One aspect of the exchange deal was that the Argentine government held out that it would not honour the old debt to the hold-outs. But there was a crucial mistake made by then in the “drafting” of the exchange bonds (they left the word “settlement” out), which would have protected the holders of the exchange bonds under the so-called Most Favoured Creditor Clause (Source). The question is: who was advising them?

The problem then was that the old bonds contained the ‘pari passu clause’, which “is a standard clause in public or private international unsecured debt obligations” (Source). It is this clause that has given NML Capital the avenue to mount its lawsuit against the Argentine government.

If you are interested in more detail – the BIS published a paper – The pari passu clause in sovereign debt instruments: developments in recent litigation – which will satiate your curiosity.

The clause basically means that in this context that all liabilities and obligations rank equally across all creditors. This was the determination of the Brussels Court of Appeals in 2000 when Elliot Associates LP (which is NML Capital is part) took on Peru over some defaulting debt.

The Brussels decision said on this matter:

The basic agreement regulating the reimbursement of the Peruvian foreign debt, also indicates that the different creditors enjoy a ‘pari passu clause’, which has as a result that the debt should be paid down equally towards all creditors in proportion to their claim.

The US District Court had ruled that NML Capital’s bonds were being “subordinated” against the exchange bonds because Argentina was honouring the latter and refusing to pay up on the former.

Further the pari passu clause protects a bond holder (with that clause as part of the contract) from being disadvantaged by “the issuance of other superior debt” and “the giving of priority to other payment obligations”.

That is why the US Supreme Court rejected the appeal by Argentina. I am sure a lawyer in international finance and contracts would have a lot more detail to add, but that essentially is what the judgement was about.

The Court’s decision prevents any third-parties (like a bank) helping Argentina get money to the exchange bond holders. So by the end of this month Argentina will be in default of its exchange bond obligations as well as the original bonds held by the vultures.

So what should it do? That depends on what it wants to achieve of-course.

One of the E-mail petitions said:

This decision poses a serious threat not only to Argentina and its people, but to all developing and developed countries.
We join this international body of opinion in calling on relevant regulatory bodies to reject the court’s decision and begin work to create a fair, independent and transparent arbitration mechanism for sovereign debt.

Why would a progressive group be calling for more multilateral bodies to oversee a nation’s debt? Why aren’t they advocating the cessation of debt-issuance altogether and the banning of any speculative financial transactions that are not related to improving the real economy of a nation (meaning about 96 per cent of financial market activity)?

There is no serious threat to Argentina and its people. NML Capital is not an army that can invade it with military force. In fact, if some thought is given to the decision, it becomes obvious that NML Capital are the losers.

Why is that? Answering that question helps us understand the way forward for Argentina.

The Argentine government has a simple response available to the US Supreme Court’s decision. First, recognise they can no longer service outstanding debt obligations via the US banking system.

Second, let all the exchange bond holders know that fact.

Third, if they want to keep paying the exchange bond holders, they should redenominate all outstanding liabilities in the local currency under a specially enacted Argentine law, therefore bringing all resolution claims etc under the aegis of the Argentine legal and banking system.

The US court system then becomes irrelevant and the US Supreme Court’s decision is rendered moot. NML Capital lose 100 per cent and the Argentine government not only saves millions in legal fees but also reasserts its currency sovereignty.

Some might argue that the redenomination is unnecessary and that the Government could still alter the legal status of the exchange bonds and keep the US dollar as the currency unit. The Government should, in general, stop issuing debt in foreign currencies and so redenomination is preferable to Argentina although it would not be so for the bond holders, who would then be exposed to exchange rate risk.

The peso has been fairly stable against the US dollar this year but steadily depreciated over the last five years (diving earlier this year).

The other option is to just default outright. The mainstream press is claiming that the Argentine government cannot afford to default because it needs the foreign capital.

That is one of those lies that divert the problem away from the obvious solution. The Government of Argentina issues its own peso. It doesn’t need to borrow in order to spend. Why then get tangled up in these complex arrangements with bond holders?

The best thing for Argentina would be for its government to announce to the world that it will never borrow again and that it will therefore not provide ‘investment’ opportunities for hedge funds etc who have no interest in the welfare of the Argentine population and only want to get financial returns.

Why should the Government spending, which is intended to maximise the welfare of the people, also, unnecessarily, provide returns to foreign creditors, especially when the nation falls on hard times these creditors turn nasty and try to avoid the fact they invested poorly?

Conclusion

The Argentine government should stop placing advertisements in American newspapers crying poor and making out this is a moral power play.

It should just assert its currency sovereignty and declare the world capital markets irrelevant – all those rapacious financiers who have no moral stake in the nation – and get on with creating work for its citizens and ensuring they all have access to education and other public services than enhance their lives.

Such a more would wipe out the claims of NML Capital. What could they do then? The only thing they can currently do is stop Argentina honouring the exchange bond liabilities. If they were brought under Argentine law then that hold is lost.

Then NML capital would have to continue scouring the world for Argentine military ships to seize along the lines of its seizure in October 2012 of an “Argentine Navy training vessel … in West Africa” (see Seizure of Ship From Argentina Forces Shake-Up).

But the aftermath of that fiasco was that NML Capital lost out too because the UN International Tribunal for the Law of the Sea – ruled in December 2012 that “in accordance with general international law, a warship enjoys immunity” and that “any act which prevents by force a warship from discharging its mission and duties is a source of conflict that may endanger friendly relations among States”.

Accordingly:

Ghana shall forthwith and unconditionally release the frigate ARA Libertad, shall ensure that the frigate ARA Libertad, its Commander and crew are able to leave the port of Tema and the maritime areas under the jurisdiction of Ghana, and shall ensure that the frigate ARA Libertad is resupplied to that end.

The Decision – is interesting reading.

The next amusing aspect of this was that the Ghana Ports and Harbours Authority sought recourse from NML Capital for the costs of the exercise.

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.