Thursday, 14 August 2014

The Argentine debt affair: a threat to the international financial system

The decision by a New York District Court judge that blocked Argentina’s payments on its restructured debt to over 92% of its creditors because of opposition from the speculative hedge funds (the ‘vulture funds’) holding the rest of the debt is no doubt bad news for the Argentine government and the Argentine people. But it is also bad news for the international financial system as a whole and for international economic governance generally.

The point has by now been made by a number of weighty observers, ranging from Economics Nobel Prize laureate Joseph Stiglitz(1) to a Deputy Director of the IMF(2), to the United Nations Conference on Trade and Development(3) and the French government, which took the unusual step of filing an amicus curiae brief before the US Supreme Court urging it to reverse the decision.(4)

The French brief sets out neatly the adverse consequences of the decision for the global financial economy: it jeopardises the ability of sovereign debtors to achieve orderly and negotiated restructurings of their external debt; and it threatens sovereign lending, particularly development aid in the form of loans to developing countries.

None of this, of course, has made any difference to the outcome of the case so far; the US Appeals Court confirmed the sentence of the District Court and the Supreme Court refused to hear the case. And this is perhaps the most serious worry coming out of this episode: that complex and delicate international financial negotiations with an impact on the lives of millions of people be decided by domestic courts that have neither the required expertise to understand the technical questions involved nor the sensitivity to international development and social justice issues to put the legal arguments in perspective.

In these respects, the Argentine case is an extreme example. The judge in the suit, Thomas P. Griesa, lacks by all accounts the basic background in economics and finance to make sense of the issues. A New York Times report on one of the latest hearings states that ‘this week’s hearing made clear that he had not completely understood the bond transactions that he had been ruling on for years.’

The problem, however, goes beyond mere incompetence. It has to do with a mindset whereby sovereign debt is no different from ordinary individual debt. Judge Griesa kept on referring in his rulings to Argentina’s ‘obligations’ as if they should override any other considerations, in the way in which individual contractual obligations do. This runs contrary to well-established understandings in the sovereign bonds market; as Stiglitz puts it, ‘all investors in sovereign bonds know that there is a risk of default — that's why the bonds can pay a far higher interest rate than U.S. bonds.’ In fact in the Argentine case the bonds were purchased by the vulture funds in the secondary market at heavily discounted prices after Argentina had declared default in 2001.

To equate this situation with ‘obligations’ in a private loan contract is to miss the very essence of sovereign debt arrangements.

The way out of this conundrum lies in the setting up of an international system for the orderly restructuring of sovereign debt that takes the issue out of domestic courts and into specialist international jurisdiction. A proposal to this effect was already made by the IMF in 2003 and related work on Principles on Responsible Sovereign Lending and Borrowing is underway in UNCTAD. What is needed now is enough political will to implement.

Notes:
(1) Joseph Stiglitz, 'A Global System Is Needed for Debt Restructuring', The New York Times, Room for Debate, 1 August 2014.
(2) 'IMF Launches Discussion of Sovereign Debt Restructuring', IMF Survey Magazine, 23 May 2013.
(3) UNCTAD, Argentina's 'vulture fund' crisis threatens profound consequences for international financial system, 25 June 2014.
(4) Available at http://www.shearman.com/~/media/Files/Services/Argentine-Sovereign-Debt/2014/Arg48-Brief-for-Republic-of-France-as-Amicus-Curiae-in-Support-032514pdf.pdf.

By Carlos Fortin, Research Associate, Institute of Development Studies

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