Argentina Default Didn't Have to Be This Way

Fix the system, even if it's too late for Argentina.

Following the twists and turns of the Argentine debt saga isn't good for one's sanity. Yesterday, the government defaulted on its debts. Or did it? It's not clear. What is clear is that this is no way to resolve sovereign-debt disputes.

Yesterday, Argentina missed payments of $539 million owed to holders of bonds it restructured after its previous default in 2001. On the face of it, that's another default.

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Yet Argentinian officials point out that there is enough money in their trustee bank in New York to make the payment. A U.S. court has forbidden the trustee to disburse the money unless Argentina also pays in full the "holdout" owners of the earlier defaulted bonds. In effect, the judge in the case has ruled that it's better for Argentina to default on all of its bonds rather than just some.

Meanwhile, because Argentina has the means and the desire to pay holders of its restructured bonds, it can claim it hasn't really defaulted -- and the owners of those bonds have reason to hope that the issue can still be resolved.

They're also keeping in mind that a separate obstacle to a resolution goes away at the end of this year. At the moment, if Argentina makes a deal with holders of the defaulted bonds, it may be legally obliged to extend the same improved terms to owners of the restructured bonds -- which it says it can't afford to do. (Needless to say, there's a dispute over how binding this obligation really is.) This equal-treatment clause expires at the end of the year. If talks can be dragged out that far, a deal will be easier to strike.

Unfortunately, the principal victims of all this uncertainty are holders of the restructured bonds. When governments mismanage their finances and need to restructure their debt, it's vital that investors in the new debts have confidence in their new loans. If they don't, there'll be less new lending, and the economic harm will be worse for everybody -- worse for the old creditors (who could end up with nothing) and in all likelihood worse for taxpayers, too (because their country's subsequent financial isolation will be greater).

Related: Argentine Default Creates Many Losers

Exactly the same logic applies to corporate bankruptcy -- a system that works well in most countries. Under corporate bankruptcy, different classes of creditors have different rights that are understood in advance, and in the case of a dispute, the court imposes its settlement on all parties. There's no such thing as a holdout.

In the case of a sovereign default, however, there can be -- which is in part why the rulings of the U.S. judge in this messy case are defensible. He is stuck with a legal code inadequate to the task, and his frustration with Argentina's recalcitrance over many years is understandable.

Argentina's fiscal incompetence is the original reason for this mess. But muddled international rules governing sovereign bankruptcy have compounded the problem. Proposals to improve the system -- to create essentially a corporate bankruptcy process for sovereign nations -- have been debated in the past. They need to be taken from the shelf, dusted off and re-examined with fresh urgency.


--Editors: Clive Crook, Michael Newman.

To contact the editor on this story:
David Shipley at davidshipley@bloomberg.net