Maybe just give them the ship and call it even? Photographer: Yamil Lage/AFP/Getty Images
Maybe just give them the ship and call it even? Photographer: Yamil Lage/AFP/Getty Images

In 2001, Argentina defaulted on its debt. In 2005 and 2010, it offered holders of the defaulted bonds a choice: They could exchange into new bonds, at around 30 cents on the dollar, or they could just not do that and get nothing. Given this choice, most bondholders took the exchange. A few hardy or angry or lazy holdouts did not. They, or their successors in interest, decided to fight to get their money back. They sued and sued and sued some more, arguing that Argentina couldn't pay its new exchange bonds without first paying back the holdouts on their old bonds. Argentina was having none of it: You should have taken the exchange offer, it said. But the holdouts persuaded Thomas Griesa, a federal judge in New York, to issue an injunction to that effect. Then they won on appeal. Then they won again in front of the Supreme Court.

Argentina had a payment due on the exchange bonds yesterday, or really a month ago but let's say yesterday. Griesa's injunction prevented Argentina from making that payment. To make the payment and avoid default, Argentina needed to come to a deal with the holdouts, so they'd agree to lift the injunction. So, after a decade of rancorous litigation, in which Argentina steadfastly insisted that the holdouts could not get a better deal than the exchange bondholders, it finally got serious about reaching a settlement. Its banking association came up with a clever plan to buy the holdouts' bonds, which would avoid certain technical problems with a settlement directly between the holdouts and Argentina.1 And Argentina's minister of the economy, Axel Kicillof, flew to New York to meet with a court-appointed mediator and the holdout funds.

And he got there. And he walked into the room. And he took a deep breath -- here I'm doing a certain amount of dramatic reconstruction2 -- and he looked the holdouts squarely in the eye. And he said (more or less):

Okay, I'm ready to deal. No more evasions. Let's get this done. I'm prepared to offer you the following settlement:

(Dramatic pause.)

You'll take the same deal that we gave the exchange bondholders in 2005. AND YOU'LL LIKE IT.

It's an amazing performance. Why did he come? The holdout bondholders have been suing for a decade to get a better deal than the exchange bondholders. They've gotten the U.S. Supreme Court to agree with them. They brought Argentina to the brink of another default. And Argentina flew its economy minister to New York to say: No, we'd still prefer not to pay you.

So now Argentina has defaulted,3 but it really did have everyone fooled. I wrote yesterday that "the odds of a near-term settlement seem to be as high as they've ever been," because I couldn't believe that Kicillof's trip to New York was just high-stakes trolling. And Argentina's U.S. dollar "discount" bonds traded over 95 cents on the dollar -- a sub-9 percent yield -- yesterday, before falling back to around 90 this morning.

So what next?

Settlement:

One possibility is that there really will be a near-term settlement. "While the market is optimistic that a solution will be found in the next few days, execution risk is higher than that during the pre-default situation,” says a guy. On the one hand, Argentina's rhetoric and brinksmanship shouldn't make you too confident of a settlement. Kicillof said yesterday the same things that Argentina has been saying for years, and that hasn't led to a settlement yet. Felix Salmon is not sanguine:

No softening of Argentina’s rhetoric whatsoever. Kicillof is taking the hard line. This default is here to stay.

On the other hand, there are rumors of progress being made on some of the creative, banks-buying-bonds proposals. And to the extent any holdouts own credit default swaps against Argentina, those swaps have (probably) been triggered and will (probably) result in a big payout, which may make the holdouts more inclined to settle now than they were yesterday.4 And I suppose Argentina's demonstration of commitment yesterday will improve its credibility in negotiations. If you were a holdout bondholder and you thought "well but Argentina can't just never pay us or anyone else," you have to be re-evaluating that theory.5 Looking a little crazy is sometimes a good negotiating strategy.

Euro Payment:

If there isn't a near-term settlement, then what happens next? I remain intrigued by the possibility of the euro bondholders getting paid. Right now Griesa has enjoined basically everyone on earth against moving money for Argentina. But there's a pretty good argument that payments on Argentina's euro-denominated bonds never flow through the judge's jurisdiction: Argentina gives the money to a bank in Buenos Aires, which transfers it to a bank in Frankfurt, which holds it in the name of a bank in Brussels, which transfers it to a London nominee for Belgian and Luxembourg clearinghouses, which pays it to bondholders. Or something.6 If that's the case, then Belgian and Luxembourgian law actually require those clearinghouses to dish out the money if Argentina sends it to them.7 So the exchange bondholders who have euro-denominated bonds may be able to convince courts in Europe to order that they get paid -- and those orders might be effective, since they would be entirely outside of U.S. jurisdiction.

This would not be great for anyone. The holdout bondholders still wouldn't get paid. Argentina would still be in default and have no access to capital markets. The exchange bondholders with U.S. dollar bonds would be getting nothing. And the U.S. legal system would find itself being ignored, after all this drama. I guess the euro bondholders would be happy, or happy-ish, though.

Exchange Offer:

There's also the possibility of an exchange offer. There are various forms of this, but the basic idea is that Argentina offers to swap its unpayable exchange bonds into new, payable exchange bonds. The simple form is: You give us your U.S. dollar or euro bonds, we give you new bonds under the law of Argentina, payable in Buenos Aires, denominated in dollars or euros. (If euro bondholders can get the euro bonds paid, then another option would be: You give us your U.S. dollar bonds, we give you new euro bonds under English law payable in Brussels.)

All of this is challenging because a lot of holders don't want to own Argentinean law bonds,8 and because Griesa has actually enjoined an exchange. So you couldn't really pitch it to bondholders in the U.S., and it'd be hard to do the mechanical steps of making the exchange because trustees and so forth would be loath to be involved.

An emerging markets hedge fund manager of my acquaintance has suggested a clever workaround, which I'll spell out in the footnotes.9 The idea is to make a "pari passu" exchange offer open on the same terms to everyone -- exchange bondholders and holdouts alike -- so as to comply with the injunction requiring equal treatment. But you do this without rewarding the holdouts, through the twist of making the offer on the same terms to everyone based on their pre-2001 claims. In other words: You just to re-do the 2005 exchange offer, which most bondholders accepted but some refused. And you do it under Belgian law, so Griesa can't help the holdouts next time.

Acceleration:

Or ... maybe nothing will happen: No settlement, no payment on euro bonds, no effort to move the bonds to friendlier jurisdictions. At some point I imagine that exchange bondholders who have not been paid will want to get paid. There is not much they can do about this, but there is a thing they can do, which is accelerate their bonds. As I said yesterday:

Acceleration means, you go to Argentina and say, "hey you're technically in default, so you actually have to pay me back the full face amount of my bonds right now," and then they laugh maniacally for like five minutes.

Subsequent events have only confirmed my faith in Argentina's ability to laugh maniacally in the face of payment demands. If you've been watching events so far and your takeaway is "oh boy litigating with Argentina looks really fun," then acceleration may be just the thing for you. Have a nice decade with that.10

Because the right takeaway from this whole pari passu saga11 might be that sovereign debt restructuring is impossible, at least for Argentina. It can't pay everyone in full, it can't convince everyone to take the same deal, and it can't get out of the clutches of the U.S. courts. The current situation is so bafflingly bad for everyone involved that it's hard to imagine that it could continue. But no one seems to be able to imagine anything better, either.

1 Principally, a "rights on future offers" clause in the exchange bonds might mean that, if the holdouts get say 60 cents on the dollar, then the exchange bondholders can demand the same thing. But this clause expires on Dec. 31, 2014. The idea of the banking association trade would be that Argentina's banks could pay the holdouts 60 cents on the dollar, lift the injunction, hold the bonds until the end of the year, and then do an exchange with Argentina that makes the banks whole.

2 I'm making all of this up entirely. I have no idea what happened and am working backward from the insane result.

3 I guess? I mean, Standard & Poor's has Argentina in default. The credit default swap jury is still out. I guess Argentina is saying it hasn't defaulted. I don't actually think there's actually an interesting debate there -- it hasn't paid bondholders so it's in default -- but I suppose others will disagree.

4 Though I mean they were pretty inclined to settle yesterday. The posture here seems to be that the holdouts propose solutions and Argentina says "naah, you can have the 2005 offer."

Anyway, I wrote about the CDS stuff yesterday. I don't know that the holdouts actually have that much, though -- there's only $1 billion net outstanding -- so this probably isn't a huge deal.

5 Joseph Cotterill on the broad implications:

Pari passu has been the holdouts’ best shot in a decade. If it doesn’t work now — even after swathes of the bond payment system and other creditors have been caught up in it — because Argentina’s response is defaulting anyway, then an enormous, centuries-in-the-making legal landmark in sovereign debt will slip from the market’s grasp all over again.

6 See footnote 5 here, and this declaration from a Bank of New York officer (and the bond prospectus). The process is:

  • Argentina deposits euros in an account at the Argentine central bank in the name of Bank of New York.
  • Those euros are transferred to a Deutsche Bank account in Frankfurt in the name of Bank of New York Mellon S.A. N.V., a Brussels bank.
  • BoNY Brussels transfers the funds to Euroclear (a Belgian clearinghouse) or Clearstream (Luxembourg).
  • Those clearinghouses appear to use Bank of New York Depositary (Limited), a London bank, as their nominee holder of the global note.

One problem here is the frequent appearance of the word "New York" in the names of these foreign corporations, which are after all subsidiaries of the Bank of New York that's actually in New York. So you could see why Griesa would think he'd have jurisdiction. And maybe he would! There's always the possibility of conflicting injunctions, where Belgian courts force BoNY Brussels to move money and then Griesa throws BoNY New York's managers in jail for contempt.

7 See pages 14-17 of the euro exchange bondholders' motion to Griesa last month.

8 Though, if an exchange offer can be done mechanically, and Argentina wants to do one, then: You should probably take it. One side effect of yesterday's drama is that Argentina has made it super clear that it has no time for holdouts.

9 Here's his proposal, via e-mail:

A resolution of the Argentine debt situation has been stuck on the contradiction between a concept of "equal treatment" based on the law and the concept of "equal treatment" based on financial criteria. The fundamental contradiction is that the law sees already-reduced claims, the Exchange Bonds, as on equal footing with never-reduced claims, the "Holdout Bonds." Economically, however, Argentina and the Exchange Bondholders point out that legally equal treatment is unequal. Now that the Exchange Bonds have fallen into default, there is a way to equilibrate legal and economic treatment. Argentina should offer a new restructuring on equal terms to all claimants. As part of this restructuring, Exchange Bonds should be "rolled back" into pre-2001 claims. Once rolled back, all claimants will have economically equivalent pre-2001 claims. When these are offered a legally equivalent settlement, we will have found a way to offer "equal treatment" on both a legal and financial basis.

Step 1: Exchange Bond rollback.

Argentina and the Exchange Bondholders agree on a formula to "roll back" the 2005 exchange (and mutatis mutandis, the 2010 exchange). We cannot rollback to old instruments, but rather to a claim that reflects an average pre-2001 bond. The general premise is that we undo any principal reduction, subtract any coupons paid (with an adjustment for the post-receipt time value of payments received), and recalculate PDI from 2001 to the present at a rate reflective of the average coupon of Argentina's defaulted pre-2001 bonds. The Exchange Bondholders now have "pre-2001" claims. This rollback can be done on a bond-by-bond basis. The result will be "pre-2001 Discount Claims", "pre-2001 Par Claims"; and "pre-2001 Global 17 Claims."

Step 2: "Pari Passu offer"

Argentina will open a new exchange offer to all defaulted claimants. Pre-2001 Discount Claims will receive new Discounts; Pre-2001 Par Claims will receive a new Par, etc. Holdout bonds will receive a mix of Discounts and Pars reflecting the relative weights of Pre-2001 Discount Claims and Pre-2001 Par Claims.

Step 3: The Exchange/Vote

Substantially simulataneously, holder of Exchange Bonds will vote on a resolution proposed by Argentina to transform their Bonds into pre-2001 Claims; and then tender these claims into an Exchange. That Exchange will likewise be open to Holdout Bonds.

Step 4: The New Instruments

The new instruments will be under Belgian Law. They will have a Trustee and Paying Agent without U.S nexus. Claimants who decline to enter the exchange will not have the benefit of an order similar to Griesa's to interfere with payment on the New Instruments.

10 Here however is Anna Gelpern with a more nuanced view on acceleration, and many other matters.

11 The phrase, of course, is Cotterill's.

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.