Learning the Lessons of the Argentine Debt Crisis
Even gauchos need some rules.
Before Argentina’s debt crisis is resolved -- and prospects have been looking better lately -- it’s worth pausing to ask why the stalemate has lasted so long. (More than a decade, but who’s counting?) Preventing these kinds of fiascos will require changing what happens when a government is unable to pay its debts.
The protracted impasse in Argentina shows what’s at stake. Increasingly frustrated by Argentina’s refusal to heed court rulings, a U.S. federal judge told its government not to pay creditors who’d agreed to settle unless it also paid the holdouts. He also forced intermediaries to help enforce his ruling.
This severe approach was understandable under the circumstances, but it sparked alarm and controversy. Both the U.S. Treasury and State Department supported Argentina’s appeal of the judge’s ruling, arguing that it encroached on Argentina's sovereign immunity and would harm New York’s attractiveness as a financial center. Nevertheless, the holdouts won resoundingly, later obtaining a ruling that they must be paid in full.
That left just one problem: The court couldn’t actually compel Argentina to pay. In addition, the decision imposed heavy costs on third parties, punished bondholders that wanted to settle, and created the potential for cascading suits lodged by "holdouts within holdouts" seeking better terms.
Unlike its predecessor, Argentina’s new government is willing to make a deal that’s reasonable. Whatever the outcome for Argentina and its creditors, however, the flaws in the system are apparent. When a company is unable to pay its debts, a bankruptcy procedure forces its creditors to cooperate in saving what can be saved and coming to a mutually beneficial outcome. No such procedure is available when the debtor is a government.
Nobody disputes that this gap needs to be filled -- Argentina is what happens otherwise -- but there’s an argument over how best to do it. Two broad approaches are possible. One relies on changing the design of contracts so that holdout creditors can be more easily forced to settle. The other is to create an international procedure akin to a corporate bankruptcy court.
Reworked contract language can encourage settlement by majority or supermajority vote, if the need arises. These kinds of provisions -- which will almost certainly be included in the bonds Argentina eventually issues -- have become the norm for emerging-market sovereign borrowers. This kind of contract helps, but it might not be enough.
Collective-action clauses haven’t always worked like they’re supposed to. They failed to make the Greek debt crisis go smoothly, for instance. As that case shows, sovereign debt restructuring is almost inevitably a disorderly process, attended by severe political stress and the intervention of foreign governments. What seemed straightforward when the contracts were drafted suddenly looks complicated -- and a damaging fight between those who want to settle and those who don’t may sometimes follow regardless.
Smarter contracts are good, but governments should also cooperate in creating an international bankruptcy-like procedure, ideally overseen by the International Monetary Fund. The two together won’t be a panacea, either, but the pairing would be a further way to promote cooperation over mutually destructive confrontation.
This idea isn’t pie-in-the-sky. An official plan for a sovereign debt restructuring mechanism was drawn up nearly 15 years ago and attracted some support, though not enough for the idea to go forward. It should be revived, preferably before rather than after the next big sovereign-debt crisis.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.