The Lessons of Our Bond War
After years of avoiding its obligations, Argentina made a deal with my firm and others that sends a good message on lending.
By PAUL SINGER – COMMENTED BY MARTIN GUZMAN
April 24, 2016 5:03 p.m. ET, published by the Wall Street Journal
On April 22, a unique chapter in the history of the international bond market drew to a close when the Republic of Argentina settled with the largest remaining holders of the bonds unresolved from its 2001 default on more than $80 billion. Elliott Management, the firm I founded and manage, was one of these holders, having purchased bonds both before and after the default [the overwhelming majority of your declared purchases was done after the default, especially in 2008, at a bargain price that went as low as 10 cents on the dollar. Over the declared purchases, you paid no more than 28 cents on the dollar on average].
The 15-year saga has generated reams of articles about what lessons should be drawn to improve the sovereign-debt restructuring process. Now that the Argentina story is winding down, we would like to add our perspective to the debate.
When we first invested in these bonds in 2001, we believed that a negotiated restructuring could help Argentina avoid default. We also believed that if we participated in a negotiation, we could help achieve a good deal for all of the country’s bondholders.
As it turned out, Argentina chose to default [there was no alternative for a country that was experiencing the major economic crisis of its history, with unemployment above 20 percent, poverty rate above 55 percent, a fall in GDP of 22 percent over the previous three years, and an amount of due interest whose full payment would have aggravated the Depression], and its leaders refused to negotiate [in the midst of this historical depression, you were buying defaulted bonds at a bargain price in secondary markets, not investing a single dollar in the country, and you litigated claiming full payment on those bonds, including the high interest that was contemplating the risk of default, and including punitive annual interest rate of 9 percent because the original holders of those bonds (i.e. not even you) had not been repaid on the due date]. Normally, sovereign restructurings are completed quickly [and they are usually not deep enough to restore debt sustainability, impeding the recovery of countries in distress, aggravating the problems of unemployment, poverty, and inequality; in fact, 51 percent of the restructurings with private creditors since 1980 were followed by another restructuring or default within a period of five years]—a 2013 study by the Moody’s rating agency put the average at around 10 months. But it was nearly three years before Argentina’s leaders even put an offer on the table.
When they finally did, bondholders—including many individual Argentines—were given a take-it-or-leave-it offer of new bonds worth just 30 cents for every dollar owed on the old bonds [This is what the country could pay at the time without harming sustainability and the recovery the country was experiencing after the social tragedy that the failure of the Washington Consensus policies of the 1990s brought. But very importantly, the country also offered GDP linked warrants, such that the country would pay more if it grew. And the spectacular recovery that followed led to sizable payments on these instruments. At the end, anyone who decided to keep these restructured bonds linked to GDP got no discount at all]. Argentina’s leaders even took the extraordinary step of passing a law prohibiting payment to any bondholder that rejected the offer [this law was irrelevant in practice, as it was suspended as many times as it was needed to reopen the swap to holdouts].
Despite these coercive tactics, more than half of Argentina’s foreign bondholders rejected Argentina’s unilateral terms [False. 76 percent of the bondholders accepted the deal]. Five years later, in 2010, Argentina repeated the 30-cent offer. Many participants in this second exchange were bondholders who were worn down by the financial crisis or just tired of waiting [the participation rate increased to 92.4 percent].
At that point, Argentina’s leaders could have easily negotiated a settlement with the remaining bondholders and put the 2001 default behind them [It wouldn’t have been easy. There was a clause in the exchange bonds, included to discourage holdout behavior, that established that the country would have to match to the restructured bondholders any superior offer that it made to the holdout bondholders before December 31, 2014—the RUFO clause]. We tried again, as we had in the past, to initiate a settlement discussion with Argentina.
Our entreaties [definition of entreaty: “an earnest or humble request.” Really??] were again refused. Instead, Argentina’s leaders chose to use us as scapegoats for the country’s mounting economic problems, insisting that bondholders like us would never be paid a single peso [actually, this is not true. Argentina offered you time and again the same terms of the restructuring of 2005 and 2010. As you bought the debt in default at cheap prices, this would have also brought very high returns for you—but true, not a return of 1,270 percent].
In 2012, the New York court charged with overseeing disputes over the bonds ordered Argentina to abide by the equal-treatment [Judge Griesa’s definition of equal treatment meant that exchange bondholders would accept a discount of 70 percent on the principal on bonds they bought before the default, and you would get above 1,500 percent for bonds you mostly bought after the default] clause of its contract, meaning that it couldn’t continue making payments on the new, discounted bonds unless it settled matters with the old bondholders.
Argentina refused to comply with the court’s ruling or to negotiate with creditors. It chose instead to go into default on the new bonds and was held in contempt of court for evading court orders [as a matter of fact, Argentina did send the money to the trustee, the Bank of New York Mellon (BONY); but BONY could not pass the money to the creditors, otherwise it would have disobeyed the order of Judge Griesa].
In late 2015, Argentines voted in a new government. By that time, the country was in default to multiple classes of bondholders and isolated from financial markets. With the economy suffering from rampant inflation and capital flight, it is little wonder that the people voted for a candidate whose slogan was “Let’s change.” [There was serious macroeconomic mismanagement during the last years of Kirchnerismo in Argentina, no doubt; but this has absolutely nothing to do with the debt restructuring, which was key for the recovery the country experienced after the 2001-2002 crisis.]
The new administration understood that the path to prosperity had to begin with re-engagement with the global economy and a quick resolution of the creditor dispute [This doesn’t mean that you played any positive role for the functioning of sovereign lending markets; on the contrary, it means that “fighting the vultures” is a public good, and we cannot rely on a country to do it by itself, because the country will have the incentives to do what’s best for the country even if it’s not the best for the world].
Our long-standing offer to negotiate was finally met with a positive response. In January, the first negotiation in 15 years commenced. As with any negotiation, there were strong differences on both sides. But the new administration recognized that this was simply a commercial dispute, and not an ideological war. That change of mind enabled talks to proceed with mutual respect and a shared commitment to solving the problem.
Once we had a willing negotiating partner, a solution was readily achievable. In February, we reached a deal that involved a meaningful but appropriate [how do you define appropriate?] discount to our claim, which has been paid as part of Argentina’s record-breaking return to international capital markets.
Throughout this saga, certain commentators and policy makers have argued that the enforcement actions imposed by U.S. courts on Argentina have set a negative precedent for future sovereign-debt restructurings [see for instance my NYTimes OpEd with Joseph Stiglitz, “How Hedge Funds Held Argentina for Ransom”, or the different chapters of Too Little, Too Late]. They claim that bondholders now have little incentive to negotiate a resolution [why would bondholders be willing to accept a sometimes necessary deep discount if they could do what you did and get returns in the order of thousands per cent?].
This line of thinking is wrong—and it risks crippling markets for sovereign debt.
In the absence of enforceability, the bonds of sovereigns with questionable credit quickly could drop to near-zero at the first sign of trouble. After all, who is going to want such bonds if holders can’t enforce their rights and sovereigns can pay whatever price, and to whichever creditors, they wish? [pure nonsense; sovereigns value the continuation of access to international credit markets. With your logic, prohibiting defaults would be optimal. But economics doesn’t work this way—sometimes the realities are such that countries do not have the resources to repay, and trying to force that event only makes matters worse.] Such a world would be far more chaotic than the imperfect but workable set of legal fallbacks that investors rely on today [what investors rely on legal fallbacks besides vulture funds?].
There must be a fair balance of power between sovereign debtors and their creditors [this current imbalance favors vulture funds], and the key to achieving that balance is the rule of law [the existing legal system has gaps that allows the likes of Paul Singer to benefit from countries’ disgraces]. If some sovereigns want to include clauses in their bonds which bind minority bondholders upon a certain vote by the majority, then they are certainly entitled to do that. [Fortunately, ICMA and the IMF have reacted to your behavior by suggesting contract language that makes your business more difficult—although not impossible. The United Nations has also launched a valuable initiative for improving sovereign debt restructuring processes that would end with your business if it could be implemented.]
However, if other sovereigns bargain for lower interest rates by inserting creditor-friendly clauses in their contracts, then, to paraphrase an important U.S. federal appeals court ruling in our case, holding them to those terms is essential for the integrity of the capital markets.
Furthermore, Argentina was described by the same court as a “uniquely recalcitrant debtor,” [what was unique about Argentina’s debt restructuring is what makes it in many dimensions a good example of how to do an exchange, and not fall into the categories of countries that continue suffering after an insufficient restructuring] and the court tailored its ruling to the specific facts of the Argentina case. We aren’t likely to see another restructuring as difficult and contentious as Argentina’s, because we aren’t likely to see another country emulate such a coercive and self-destructive approach [and because your victory will discourage other distressed debtors to fight more aggressively, even if this means settling on terms that would not restore sustainability, leading to more unemployment, poverty, and fewer opportunities for many].
If the official sector overreacts to this extreme outlier by devoting its energies to preventing the enforcement of sovereign-debt contracts, then the world will likely see a significant drying up of sovereign lending [you have the intentions of continuing doing the same, perhaps even at a larger scale…]. The true recipe for market failure would be for courts to stop enforcing debt contracts, or to enforce them only selectively when it comes to sovereigns.
The lessons of this story are clear: The rule of law is not a liability for a country. It is an asset [that’s why the world needs to create a rule of law for sovereign debt that works, unlike what we have now]. Sovereign-debt restructurings can quickly and easily be achieved when both sides are willing to negotiate in good faith [Argentina’s experience with GDP warrants is an example of good-faith negotiation; on the contrary, your whole vulture business is the example of lack of good-faith]. And the key to ensuring timely and orderly restructurings lies not in vitiating the enforcement of contractual rights, but in encouraging sovereigns in need of restructuring to avoid Argentina’s costly and unnecessary mistakes. [Your socially unproductive and predatory behavior earned you 2+ billion dollars (from the business opportunity that the economic crisis of a country created for you) because the law lets you do what you did, and the Judge’s interpretation of pari passu was at least peculiar. Your victory is bad news for the world. With more reasonable laws, the system would work better. But there is a big problem: you have influence in how the rules of the game are determined. Before 2004, it was prohibited to buy debt in default with the intent of suing the issuer—the so-called Champerty law. But Champerty was repealed by the NY legislature in 2004, ensuring the good health of your business. Interestingly, the bill proposing the elimination was presented by New York State Senator John Marchi. I happened to discover that you donated money to “John Marchi and friends” the very same year. What you did is legal. But others believe this is absolutely corrupt. By buying influence, people like you manage to make legal what is corrupt—and makes us live in a system of “Corruption, American style”, where the rules are written by the “big finance” and for the “big finance”.]
Mr. Singer is the founder and co-CEO of Elliott Management Corp.
Martin Guzman is a Postdoctoral Research Scholar at Columbia University, and holds a PhD in Economics from Brown University.