(Photo Source: argentinaindependent.com)
In the struggle between Argentina and a “vulture fund”, a New York judge has sided with the vultures. It’s a move that could have significant consequences in Europe. Public pressure may yet force a turning point: the introduction of an agreed process for sovereign default.
Argentina is engaged in an epic legal struggle with a New York ‘vulture fund’ – Elliott Management Corporation. In the meantime Greece’s debt agony persists, with her major official creditors – the IMF, EU and ECB, clearly divided, and unable to agree on a resolution to the crisis.
Both ongoing sovereign debt crises remind us yet again that there is no international framework of law for the orderly management of the de facto bankruptcy of a sovereign.
In the absence of what would be a fair and just international insolvency law, the sovereign debtor has few choices.
They can take the path chosen by Nicolae Ceaușescu, Romania’s Head of State from 1967 to 1989 – namely, to honour debts, regardless of the cost to their citizens. Or that chosen by Russia’s leaders in 1998 – to default.
Ceaușescu chose to repay debts even though the loans had largely been geo-political in purpose. (The west, playing divide and rule, showered Ceaușescu with IMF loans, believing he was hostile to the Soviet Union.) To do so, he had to starve the Romanian people of food. This was because with the exception of agricultural goods, Romania had few exports that could raise the hard currency (e.g. US dollars) to repay foreign debts. As a result, most of Romania’s agricultural output went to foreign creditors.
The cost of repaying debts was calamitous for Romanians, and for Ceaușescu and his wife. Revolution broke out in Romania in 1989, the year the debts were fully paid off. Soon after, the Ceaușescus were captured, subjected to a show trial, lined up against a wall, and shot dead by a firing squad – in such haste that the event was not captured by a watching film crew.
Russia in 1998 chose a different path. After being showered with $22.6 billion in loans from the IMF and World Bank on 13 July 1998, Russia defaulted on its sovereign debt on 17th August of that year. The government devalued the ruble, and declared a suspension of payments by commercial banks to foreign creditors. 
For Russians the aftermath of default was happier than the path chosen for Romania. Two years later real GDP growth grew 8.3% in 2000 and roughly 5% in 2001. As the St. Louis Fed argues,
“…most of the recovery could be attributed to the import substitution effect after the devaluation; the increase in world prices for Russia’s oil, gas, and commodity exports; monetary policies; and fiscal policies that led to the first federal budget surplus (in 2000) since the formation of the Russian Federation.”
Since the default, Russia has not looked back. Growth powered ahead for ten years, until a deep but brief recession in 2009-10.
I am reminded of these tumultuous times by events these past few weeks in a local, district court in New York.
Paul Singer founder of the notorious vulture Fund Elliott Management Corporation (EMC) used this Wall St-friendly jurisdiction to mount a challenge for full repayment of Argentine debts. These had been re-structured in 2005 with most creditors accepting a 70% ‘haircut’. Elliott’s chose instead to ‘hold out’ i.e. refuse to combine with other creditors, and then purchase outstanding ‘distressed’ debts at a massive discount. Like vultures, EMC waited, circling the weakened economy of Argentina until there were signs of life. They then pounced and are now demanding that discounted debts be repaid in full, with compounded interest added.
This policy is both unfair to the sovereign and its taxpayers; but also to other creditors that agreed collectively to a ‘haircut’.
The local judge, Judge Griesa, chose to side with this ‘holdout’ creditor, and directed Argentina’s bank in New York to pay Elliott $1.3bn by 15 December. If the bank were to ignore its client (Argentina’s) instructions and conform to the judge’s ruling, this would threaten both the confidentiality of client relationships, but also payments due to Argentina’s other ‘legitimate’ creditors.
The ruling is therefore causing much consternation in international bond markets. Paul Singer may finally be uniting his enemies. The ruling could result in Argentina deciding to ‘offshore’ payments to her international creditors – bypassing New York banks. Furthermore bond investors may not want to risk having ‘haircuts’ on their agreed debt service payments ruled on unilaterally by New York’s district judges – many of whom may have little understanding of the macroeconomics or dynamics of sovereign debt negotiations. They may therefore shun New York in future as a jurisdiction for registering bond purchases.
This disruptive and disorderly management of sovereign defaults is the reason that so many have backed the proposal of Kunibert Raffer of the University of Vienna (the ‘Raffer proposal’) for a just and fair sovereign insolvency process that would be based on the application of justice and reason; that would protect human rights – both those of the debtor as well as the rights of creditors. Above all, Raffer’s proposal would ensure that neither creditors nor debtors can influence or decide on their own claims or payments. Instead a neutral judge, chosen and agreed by both sides, would arbitrate between both creditors and debtor.
Will Argentina’s epic struggle with Elliott Management Corporation lead to the enlightened adoption of the Raffer Proposal – just as enlightened creditors backed Britain’s Bankrupts (England) Act 1825?
There are reasons to be cheerful. Back in 2001 Andy Haldane, of the International Finance Division of the Bank of England co-authored a paper with Mark Kruger of the Bank of Canada that helped persuade the IMF of the need for change. Soon after, the IMF deputy Managing Director, Anne Krueger proposed a ‘Sovereign Debt Restructuring Mechanism’. This too fell by the wayside, owing to lobbying by Wall St’s vulture funds; but also to the IMF’s insistence that its own debts could never be included in any process.
This may be a good time for Andy Haldane and the Bank of England to re-launch its initiative, and back the Raffer Proposal.
For the times they may be a’changing. A New York judge’s acceptance of Paul Singer’s audacious claim to be repaid in full, to the detriment of international creditors and New York banks, as well as Argentina, may just be a step too far.
As Mario Bleier, ex-governor of the central Bank of Argentina argues in the FT (25th Nov, 2012) :
“Judge Thomas Griesa’s decision is disruptive for capital markets, setting perverse incentives and running against fundamental financial principles …and could have serious consequences not only for Argentina but, more important, for many recent and probably future debt relief cases.”
We may be witnessing the gradual demise, if not the extinction, of vulture funds.
 A Case Study of a Currency Crisis: The Russian Default of 1998 by Abbigail J. Chiodo and Michael T. Owyang. November-December, 2002. St Louis Fed. http://research.stlouisfed.org/publications/review/02/11/ChiodoOwyang.pdf