South America has been a special part of my life for four decades. I have lived many years in Brasil and Peru. I am married to an incredible lady from Argentina. I want to share South America with you.
A creditor paid more to take on the risk of a default cannot then be surprised by it
Not far from the London offices of the Financial Times was the Marshalsea prison where debtors used to be sent. In the 18th century, more than half of London’s prisoners were incarcerated for their undischarged debt. The moral hazard Taliban of the day insisted that such harsh penalties were necessary. Then, in 1869, imprisonment for debt was abolished and bankruptcy introduced. Both economy and society survived.
Things sometimes go wrong. Sometimes this is due to bad luck and sometimes to irresponsibility. But society needs a way to allow people to start over again. This is why we have bankruptcy. Indeed, we allow the most important private actors in our economies – companies – to enjoy limited liability. This lets shareholders walk away from their companies’ debts unscathed. That idea, too, was condemned as a licence to irresponsibility when introduced. Limited liability does bring problems, notably in highly leveraged businesses (such as banking). The ease with which US corporations can walk away from their creditors is breathtaking. But this is better than unlimited liability.
A similar logic applies to countries. Sometimes their governments borrow more than they turn out to be able to afford. If they have borrowed in domestic currency, they can inflate their debt away. But if they have borrowed in foreign currency, that possibility disappears. Usually, it is countries with a history of fiscal irresponsibility that find themselves obliged to borrow in foreign currencies. The eurozone has put its members in the same position: for each government, the euro is close to being a foreign currency. When the costs of servicing such debts become too high, then restructuring – default – becomes necessary. AsCarmen Reinhart and Kenneth Rogoff of Harvard University showed in This Time is Different, this is an old story.
As I argued at the time, Argentina found itself in this position at the turn of the century. It was difficult to feel much sympathy for the country, which suffered from chronic mismanagement before its default in December 2001 and was to suffer yet more thereafter. But it had become impossible to service its public debt of $132bn at tolerable cost. Moreover, creditors had been rewarded for the possibility of default. Even at its lowest point, in September 1997, the spread of Argentine dollar bonds over US Treasuries was close to three percentage points. A creditor compensated for the risk of a default cannot be surprised by it. The solution is portfolio diversification.
While the principle of sovereign debt restructuring is compelling, in practice it is difficult. No court can seize and then liquidate a country’s entire assets. This legal limbo creates two opposing dangers: the first is that it is too easy for a country to walk away from its debts; the second is that it is too hard. The Argentine story illustrates both: confronted with an intransigent government, holders of 93 per cent of defaulted debt accepted exchanges for debt with a hugely reduced face value; but “holdouts”, who reject such an exchange, have blocked a clean resolution. The mess has lasted more than 12 years from the default.
If Argentina is forced to pay holdouts in full, the price will be borne by Argentines
As first deputy managing director of the International Monetary Fund, Anne Krueger advanced a proposal for a sovereign debt restructuring mechanism in 2002. She argued that the restructuring process could be delayed or blocked if some creditors were able to hold out for full payment.
Her ideas were more supranational than governments – above all, the US – could bear. But “collective action clauses” were at least introduced. Yet such clauses might not have prevented the success of holdouts over Argentina, led by Paul Singer of Elliott Management. As the IMF recently noted, these clauses “typically only bind holders of the same issuance”. A holdout creditor can “neutralise the operation of such clauses” if they secure a blocking position, normally more than 25 per cent.
Moreover, adds the IMF, US courts have interpreted a “boiler plate provision” of these contracts (the so-called pari passu clause) as requiring a sovereign debtor to make full payment on a defaulted claim if it makes any payments on restructured bonds. In addition, the US courts will force financial intermediaries to help creditors obtain hold of the sovereign’s assets. All this will make restructurings harder. Why should creditors accept an exchange for instruments with reduced value in future?
I am no lawyer, but to me the idea of equal treatment means treating like cases in the same way. Yet creditors who have accepted exchanges and holdouts are not like cases. To force debtors to treat them equally seems wrong. Moreover, the argument that holdouts are helping Argentines by punishing government corruption is absurd. It is up to Argentines to choose the government they desire. Worse, if Argentina is forced to pay holdouts in full, the price will be borne by Argentines. This is extortion backed by the US judiciary.
The immediate issue is how Argentina might settle these cases. The options – paying the holdouts, reaching a deal with them, transferring restructured debt into domestic law and outright default – look costly, humiliating, difficult or damaging. Worse are the longer-term implications for debt restructurings.
One possibility is to eliminate the pari passu clause. Another is to introduce stronger collective action clauses, particularly ones that cover all outstanding instruments. Another is to shift issuance from New York. But all three would apply only in future. Another possibility would be to amend US law. A final possibility, as José Antonio Ocampo of Columbia University notes, is to revive the idea of a global mechanism. These last two options look very unlikely.
Yet in a world of global capital flows, a workable mechanism for restructuring sovereign debt is not an optional extra. It is possible that Argentina is an exceptional case. It is more likely that the interpretation of the pari passu clause and the ability to pursue assets will now make it more difficult to restructure debt. A world in which the choice for sovereigns and their creditors is between full payment and absolute non-payment would be as bad as one in which debtors had to choose between starvation and prison. A better way must now be found.
Banco de Chile’s TV commercial for the World Cup uses a potent national symbol: the Chilean miners who were trapped underground for 69 days in 2010. In the commercial, the men line up like a football team, national flags flying, and their leader Mario Sepulveda asks: “Spain is difficult? Netherlands is difficult? We don’t fear the ‘group of death’, because we have beaten death before!”
His men fill tins with local soil to spread across Chile’s training ground in Brazil.
The commercial elicited a Dutch parody, in which a few Dutchmen line up in a meadow and their leader intones: “We Dutchmen have been trapped all our lives. In the Netherlands.” The Dutchmen then enumerate the difficulties of Dutch life: shopping trolleys with a missing wheel, smartphones with poor reception, declining house prices, et cetera. The parody angered some Chileans, but amused others who felt uncomfortable at the bank’s use of a human drama.
Still, the miners’ commercial got two things right: Chilean passion for the national team, which is high even by World Cup standards, and Sepulveda’s cry, “Nothing is impossible for a Chilean”.
Chile meet the Dutch in São Paulo on Monday already certain of reaching the knockout rounds after clear victories over Australia and, gloriously, world champions Spain. “We are the rebels of this tournament,” says their Argentine coach Jorge Sampaoli.
If his team beat Holland to top the group, they will probably avoid scary Brazil in the next round. Harold Mayne-Nicholls, former president of Chile’s Football Association, says this is the most successful Chilean side he can recall. “And there’s still room to grow.”
In 1962 Chile finished third in an unusually brutal World Cup at home. Their subsequent football history was unhappier. After General Augusto Pinochet’s coup in 1973, he turned the national stadium into a torture camp. Moreover, adds Brenda Elsey, author of Citizens and Sportsmen on Chilean football and politics, “almost every neighbourhood stadium was used to detain people”.
In 1989, during a Brazil-Chile game at Rio’s Maracanã, the Chilean keeper Roberto Rojas cut his head with a razor blade but claimed to have been struck by a flare from the crowd. He was unmasked, and Chile were banned from the 1994 World Cup.
For many years Chile played defensively and lost. This history helps explain the raucous delight of the Chilean fans in Brazil. Tens of thousands are here, communicating with locals in a Spanish-Portuguese mix known as “portunhol”. Some sleep in the cars they drove up in, and wash in the free showers on Rio’s beaches. Before the Spain-Chile match, bizarrely, ticketless Chilean fans invaded the Maracanã media centre. One man hauled off by stewards looked at least 70 years old.
Back home, large crowds celebrate victories in the wintry cold of Santiago’s Plaza Italia, waving flags that sometimes have political messages inscribed in the white bar, says Elsey. Inevitably, a national experience on this scale has sociopolitical aspects. Issues of race, rarely discussed in Chile, are now surfacing. Midfielder Jean Beausejour, son of a Haitian father and Chilean mother, is nicknamed Palmatoria after a Brazilian blackface character in a 1960s comic.
The moniker, which he hates, even appears in his official Fifa biography. Beausejour has spoken proudly of his mother’s Mapuche indigenous heritage – again something seldom done in Chile, notes Elsey.
But Chileans of all political shades are proud of their attacking team. Keeper Claudio Bravo (reportedly about to join Barcelona) plays like a last defender, the three-man defence includes two natural midfielders, and all Chile’s men pass like midfielders. This collectivist team doesn’t depend on one genius like certain neighbouring countries Chileans could mention. Five different players have scored Chile’s five goals.
Chileans are enjoying the unaccustomed global spotlight. Many more are planning Brazilian jaunts for next weekend’s game, says Mayne-Nicholls. The Chileans, though tattooed to the eyebrows, have acquired the status of the loveable small boys of international football: playing brightly, but never irritating the grown-ups by winning anything. This time, says their forward Alexis Sanchez, the aim is to lift the trophy.
Buenos Aires has sent mixed signals since Monday’sSupreme Court ruling ordering the country to pay billions of dollars to “holdout” creditors who refused to take part in debt restructurings in 2005 and 2010 at the same time as it makes any repayment to those who agreed to the deals. Ms Fernández slammed the ruling in a televised address, in which she would not yield to “extortion.”
But on Friday, the president was keen to quash the uncertainty which has rattled local markets, saying that she had given instructions to the economy minister Axel Kicillof to tell lawyers to find a “fair and equal” solution for 100 per cent of bondholders and not just holdouts.
Earlier this week, lawyers for Argentina told a US court that Buenos Aires would send a delegation to New York next week to negotiate with the holdouts, led by NML Capital, and so settle a 12-year long legal dispute that has kept the country locked out of capital markets.
At the Rosario speech, which was also attended by vice-president Amado Boudou, Ms Fernández continued her criticism of the hedge funds that she refers to as “vulture funds”.
“I can’t believe any country’s legislation in the world says that you have to ruin 92.4 per cent in order to save 1 per cent,” she said. “I don’t think there’s judicial legislation that can justify that.”
The president was referring to the group of holdouts led by NML Capital, a subsidiary of Elliott Capital Management, a hedge fund controlled by the US billionaire investor Paul Singer.
New York district Judge Thomas Griesa ruled in 2012 that if Argentina continued payments to creditors who participated in the two debt restructurings it must also pay the full value of the bonds owned by holdouts. The Supreme Court upheld the decision on Monday.
Buenos Aires claims it would have to pay $15bn, over half its reserves, although analysts claim the figure is $6bn-$8bn.
Ms Fernández’s speech, in which she emphasised the need to leave a lasting legacy after she leaves office in just under two years’ time, still leaves it unclear how a potential default at the end of June will be avoided.
The mixed messages from the government are “probably a reflection of divisions inside the government or doubts about which direction to take,” said Buenos Aires-based analyst Federico Thomsen. “The handling has been very incompetent.”