On Monday, Argentina lost its appeal against Elliott Management in the U.S. Supreme Court. That means that, leaving aside this footnote,1 Argentina needs to either negotiate a settlement with Elliott over billions of dollars in unpaid debt in the next two weeks, or default on its current debts on June 30. This seems bad for Argentina, and it is. But in a weird way, it almost puts Argentina in a stronger negotiating position than Elliott.
(Another self-conscious footnote: If you have no idea what I'm talking about, there's some basic background down here.2 )
On the one hand: Default is bad for Argentina. But it might not be that bad. It's a strange technicality-driven default, not a "real" one: Argentina has the desire and capacity to make its interest payments on the exchange bonds; it can't because a vulture fund (Argentina's words) and a New York court won't let it.
Now bondholders like desire and capacity, but they prefer money; "we tried, but we can't give you your money" is not a great thing to tell them. But there are ways to get them their money even after default. I mean, Argentina has lots of experience with that! You default, you offer bondholders something in exchange for their bonds, and they take it. If what you give them preserves value, they're not that mad at you and are willing to continue to lend to you.
That seems to be what Argentina has in mind. It has said as much (though, to be fair, it has said a bunch of things). The idea would be to offer bondholders the chance to swap their newly defaulted bonds into new, Argentine-law, Argentine-payment-system bonds. These bonds, and the banks in Buenos Aires that processed the payments, would not be subject to U.S. court orders, so Argentina could just keep paying interest on them. The economics of the swap could be very simple -- for every $X face amount of Y-year, Z percent, U.S. dollar, New York-law bonds that you own now, you get $X of Y-year, Z percent U.S. dollar local-law bonds -- and so would preserve value for holders, mostly.3 There are other, reasonably equivalent ways to get to the same place, like defaulting, doing a local-law offering for cash, and using the proceeds to fund a buyback of the defaulted bonds.4
This would be a pain, and there's plenty of uncertainty about the process of the exchange and the viability of local-law bonds, but it might work. Importantly, there's a hint of this outcome -- temporary default but preservation of value -- in market prices. Credit default swaps on Argentina trade at levels that imply around a 50/50 probability of default in the next couple of weeks.5 But Argentine bonds are trading at levels that ... look, they're not great, but I see the 8.28 of 2033 trading at around 76 cents on the dollar, for a yield of a bit under 12 percent.6 You would not pay $76 for something with equal odds of (1) being worth zero in two weeks and (2) being worth, I don't know, $85 in two weeks.7 The conclusion has to be: There's a high (50 percent, not 90 percent) likelihood of default, but there's also a high likelihood that default would work out more or less OK for the exchange bondholders.
Which means that it would work out OK for Argentina. The goal, for Argentina, is to get on decent terms with capital markets. If its exchange bondholders are happy, or happy-ish -- if it keeps its promises to them, and preserves value for them -- then it's happy.
On the other hand: Default is terrible for Elliott! Elliott's leverage over Argentina is that it can force Argentina to default on its bonds, which would be a big setback in its efforts to rejoin the world capital markets. But that's a one-time event: Once it happens, Elliott's leverage evaporates. Once Argentina defaults, it's defaulted; Elliott can't make it default any more. And if it succeeds in moving the bulk of the exchange bonds to Argentina, it can keep paying its friendly bondholders -- and rebuilding capital-markets credibility -- while ignoring the New York orders to pay Elliott and the other holdouts.
Without its strongest source of leverage -- the ability to stop payments on Argentina's exchange bonds -- Elliott would be left with, basically, billions of dollars of hard-to-enforce New York judgments against Argentina.8 Elliott has had those judgments for years,and while it's had occasional fun seizing Argentine navy ships, those adventures have not led to it getting much money back. And Elliott, as a bondholder, is primarily interested in money, not buccaneering.
So it seems to me like a default would be very unpleasant, but survivable, for Argentina. But after default, Argentina would in a sense have nothing left to lose by continuing to defy Elliott. Which suggests that, after a default, the value of Elliott's claims would drop rather uncomfortably.
[Update: On the other hand, it's widely assumed that Elliott owns massive amounts of Argentine CDS itself. This would trigger, and be profitable, on a default, cushioning the blow quite a bit. Hard to know exactly how much: DTCC shows $21.7 billion of gross Argentine CDS outstanding, but only $906 million net; if the net number actually represents reality then Elliott's payday from negotiating would seem to be much bigger than from a default.]
If you look at the situation through this lens, some things make a bit more sense. For instance, there's the fact that more or less immediately after winning in the Supreme Court, Elliott has become quite conciliatory:
Singer’s Elliott Management Corp. is willing to consider accepting bonds as payment from Argentina in exchange for defaulted debt, according to a person familiar with the company’s strategy. Any decision to accept the securities would depend on the terms offered, said the person, who asked not to be identified because the information is private.
This new friendly tone, after a comprehensive win in a bitter, long-running fight, might seem odd. But the time for Elliott to settle is really now, so it's trying to be approachable and ready to deal.
Argentina, on the other hand, is acting crazy:
First, President Cristina Fernandez de Kirchner vowed to defy the order to pay out $1.5 billion to billionaire hedge fund manager Paul Singer, a stance her economy minister echoed when he mapped out a plan to skirt the ruling the next day. Her lawyer in Manhattan then reversed course yesterday, saying the government was willing to negotiate with creditors. That new conciliatory line didn’t last long either. Fernandez’s cabinet chief said this morning that the government has now decided against sending officials to New York for talks.
This is quite plausibly because they have no idea what they're doing,9 but it also makes sense as an effort to negotiate from a position of both strength ("If you don't settle on decent terms, we're ready to ignore you and exchange into local law bonds") and also desperation-as-strength ("If you don't settle on decent terms, we are crazy people and perfectly happy to push the big red default button").
Where does that leave you? I have no idea. One possibility is some sort of short-term negotiated agreement-to-agree, in which Elliott agrees to stay the order past June 30, allowing Argentina to make its interest payment and avoid default, in exchange for a promise to negotiate a settlement and some indication of good faith -- a down payment into escrow, say, and/or a promise to stop working on a local-law-exchange process.10 That way Argentina avoids default, and Elliott gets to avoid negotiating with an Argentina that's looking default in the eye and thinking it doesn't look too bad. A calmer negotiation, a bit more removed from the shadow of default, might be better for both sides.
The Internet being what it is -- delightful! -- it is full of schemes for Argentina to avoid default without paying the holdout creditors. On my cursory reading none seem to work, but who knows. A few:
- Argentina sends the money to Bank of New York Mellon, its indenture trustee. The trustee, bound by Judge Thomas Griesa's order, doesn't send the money to the bondholders. Argentina is in technical compliance. (It's not though.)
- Argentina asks for reconsideration at the Supreme Court and tries to extend the stay on Griesa's order for another month, allowing it to make the June 30 payment. This seems not to work; see the comments here.
- Most popularly, Argentina conducts a voluntary exchange of New York law bonds into Argentina-law local bonds, and gets enough participation to satisfy its collective action clause and move its entire stock of New York law debt to Argentina. This is a popular theory because Argentina actually said this week that this is the plan; Joseph Cotterill, the dean of the pari passu press, has discussed it here and here and elsewhere. It seems problematic for any number of reasons. One, the intermediaries doing the exchange would have to worry about being in contempt of court for abetting Argentina's efforts to avoid the injunction. Two, it seems unlikely that Argentina would get a lot of participation: A lot of holders can't or won't hold Argentine-law bonds, and even if you could wouldn't you prefer that Argentina settle with Elliott and not put you through this rigamarole? So you're not going to exchange unless it's the only way to get paid, and at this point you might not believe that. Three, and most important: no way an exchange gets done in two weeks.
- Argentina had some bonds.
- It couldn't pay them.
- In 2005 and 2010, it did distressed exchange offers, replacing those bonds with new bonds at a 70 percent discount.
- Most holders accepted the exchange offers and now hold what are called "exchange bonds."
- The exchange bonds are sort of normal: Argentina has been paying interest on them and seems committed to honoring them.
- But some holders -- the "holdouts" -- didn't accept the exchange offers and still own the old bonds.
- The old bonds contain a "pari passu clause" that says they need to be equal in right of payment with all Argentine bonds.
- This is a hoary survival of the olden days, and no one knows what it means.
- One obvious thing it could mean is that Argentina had to keep honoring the holdout bonds, paying interest and principal as they came due, if it was also honoring the exchange bonds. That would be weird -- it would make restructuring effectively impossible -- but it is kind of what the words say.
- Argentina did not keep honoring those bonds and stopped paying interest on them.
- Some hedge funds -- especially Elliott Management and Aurelius, and also Kenneth Dart -- bought a bunch of those old bonds at very distressed prices.
- Then they sued, arguing that the clause meant what it said.
- (Confusingly the fund that sued is called NML Capital; it's a division of Elliott, which is run by Paul Singer, and I just refer to it as "Elliott" in the text.)
- NML won a famous victory from Judge Thomas Griesa of the U.S. District Court for the Southern District of New York.
- Then it won on appeal, and kept winning.
- What NML's win means -- what Griesa's order says -- is that Argentina can't make any payments on the exchange bonds unless it makes big payments (not just regular interest but all sorts of past-due stuff) on the holdout bonds.
- Which it does not want to do.
- The order also prohibits various other parties -- indenture trustees, payment systems -- from aiding Argentina in violating the order, for instance by routing payments from Argentina to the bondholders.
- So Argentina can't just ignore the order and pay its exchange bondholders: All the financial-system plumbing has been ordered not to help it with that. And it needs the plumbing.
- Griesa's order was stayed during various appeals, but now those appeals have run out.
- Argentina has a big interest payment due on June 30, which it now can't pay.
I mean, you probably lose some value from the move to local law.
In footnote 1 I said that this sort of exchange wouldn't work to stave off default, but there are reasons to think it might work better after default. Such as:
- Argentina has already defaulted, so it has got all the time it needs to do the exchange.
- It has already defaulted, so holders really believe that if they don't exchange they'll get zero, which should push up participation.
- It has already defaulted, so the collective action clause threshold is irrelevant: If anyone doesn't exchange, they're just left with a bond that Argentina has promised not to pay -- and with some strong precedent of Argentina sticking to its guns.
- If you're a holder, doing a voluntary exchange next week might feel a little like abetting Argentina's efforts to avoid the court order. Taking an offer of something after Argentina has already defaulted doesn't feel so much like that.
- Arguably that's even true of banks and other intermediaries, though I feel less good about that.
4 That idea, from Felix Salmon, strikes me as worse than a post-default exchange. The obvious buyers of new bonds are the guys in the old bonds, so the exchange seems like a simpler way of rolling them over than asking them for cash and then giving it back to them. And there are difficult pricing questions that you avoid by just doing a one-for-one, terms-preserving swap. On the other hand, perhaps it is slightly superior from the standpoint of not running afoul of the court order.
5 Dumb math:
- I see 1-year CDS trading at around 34 points up front. (Source: Bloomberg CMAN data as of yesterday.)
- Very low-coupon Argentine bonds trade at around 20-40 cents on the dollar.
- If you assume that they don't lose much value on a temporary default -- sort of a bootstrapping assumption but whatever -- then you'd deliver those bonds into CDS and get back par, for a total gain to CDS holders on default of 60-80 cents on the dollar, depending on auction dynamics.
- Call it 70 cents on the dollar, so you're paying 34 for a chance to get 70. Ignoring discounting -- it's two weeks -- and you get an implied 50/50 chance of default.
6 That's Bloomberg ARGENT 8.28 12/31/33 <Govt> HP. For a not great comparison, the Greek 10-year yields under 6 percent (though in euros).
7 Because it seems unlikely to go to par if they settle with Elliott. That bond hasn't traded above $85 this year, though of course the Elliott overhang has existed for much longer than that. It's certainly not going to $150 anyway.
8 Hard to enforce because foreign sovereign immunity prevents Elliott from seizing Argentine assets in the U.S., and similar rules mostly prevail abroad. Argentina's other loss in the Supreme Court on Monday was over this issue: Elliott won the right to conduct discovery on Argentina's foreign assets, in the hopes of seizing them. Justice Ruth Bader Ginsburg's very brief dissent in that case is worth reading. Here are two of its three paragraphs, omitting citations:
A court in the United States has no warrant to indulge the assumption that, outside our country, the sky may be the limit for attaching a foreign sovereign's property in order to execute a U.S. judgment against the foreign sovereign. Cf. §1602 ("Under international law, . . . th[e] commercial property [of a state] may be levied upon for the satisfaction of judgments rendered against [the state] in connection with [its] commercial activities." (emphasis added)). Without proof of any kind that other nations broadly expose a foreign sovereign's property to arrest, attachment or execution, a more modest assumption is in order.
Unless and until the judgment debtor, here, NML, proves that other nations would allow unconstrained access to Argentina's assets, I would be guided by the one law we know for sure-our own. That guide is all the more appropriate, as our law coincides with the international norm. Accordingly, I would limit NML's discovery to property used here or abroad "in connection with . . . commercial activities." I therefore dissent from the sweeping examination of Argentina's worldwide assets the Court exorbitantly approves today.
9 Some more quotes from that Bloomberg News article:
“They’re acting like a wounded animal in a corner,” Jorge Mariscal, the chief investment officer for emerging markets at UBS Wealth Management, which oversees $1 trillion in invested assets, said by phone from London. “They don’t really know which way to turn that will ultimately solve their problems and save face internally. I think part of it is negotiating tactics, but I think more than anything else it’s not exactly knowing what to do.”
“The court’s decision to lift the stay took the government by surprise and without a clear strategy,” said Maximiliano Castillo, the director of Buenos Aires-based economic research company ACM. “Evidently they’re playing an ambivalent and risky negotiation strategy.”
10 Another important benefit of delay is that Argentina's RUFO clause might prevent it from reaching a settlement with Elliott before the end of 2014. A settlement in January 2015 would be legally cleaner than one reached in the next two weeks.
To contact the writer of this article: Matt Levine at firstname.lastname@example.org.
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