Argentina – Deadbeat State Goes On The Attack

Argentina Wants to Investigate Holdouts for “Insider Trading”

In a way this is really the joke of the week. Argentina just announced that its financial market oversight authority launched an “investigation” into the so-called “holdouts”. This is the term for bondholders who insist that the government pay its debts and have refused to accept the terrible deal the government offered in the restructuring of the foreign debt mountain it accumulated prior to its 2001 default. Below are a few excerpts from a press report on the situation.

“Argentina's markets watchdog on Monday launched an investigation into what it believes may have been unlawful speculation by holdout creditors whose litigation against the country for repayment of their defaulted bonds pushed it into a new default last week.

The government also reiterated its fierce criticism of the mediator in debt talks with the holdout hedge funds for being "biased" and a "spokesman of the vulture funds".

The head of Argentina's Securities Commission Alejandro Vanoli said it had asked its U.S. counterpart for information on trade of Argentina's sovereign debt and credit default swaps (CDS), derivatives used to insure against default.

The watchdog wanted to check if holdouts who rejected Argentina's restructuring in the wake of its 2002 default held or traded CDS while they took part in negotiations with Argentina which could trigger a default.

"The use of insider information, which would be the case here, and market manipulation are crimes in Argentina, they are crimes in the United States, and they imply economic sanctions and eventually criminal sanctions," Vanoli told a news conference.

Over nearly the last two years, sources familiar with the position of the holdouts have told Reuters the firms are not holders of CDS positions. A new source said on Monday that this stance has not changed.

"There is absolutely no evidence to demonstrate that the holdouts hold Argentine CDS positions. No proof," said the source, who is familiar with the holdout positions.

(emphasis added)

We would add to this that even if the hold-outs did hold large CDS positions, why should that be illegal? We believe that it would not be illegal at all. After all,  bondholders have a legitimate interest in protecting their positions, especially when the debt they hold has been issued by a government that has been bankrupt for about one third of the country's history as an independent state.

In other words, the debt issuer is a nation well known for having profligate governments welshing on their debts. Why on earth should a bondholder not have the right to protect himself with CDS?

Moreover, even if a case could be made that it was somehow not legitimate for holdout bondholders to safeguard their positions with CDS, Argentina's government would have no standing on the issue, since it is not a counterparty to the CDS agreements. The actual counterparties who had to pay, evidently did so without demur:

“On Friday, a committee facilitated by the International Swaps and Derivatives Association voted unanimously to call the missed coupon payment a "credit event", triggering a payout process on CDS worth an estimated $1 billion.

"The holdouts were awarded $1.33 billion and the interest too, right? Well there is just $1 billion in potential payout on the CDS and that would mean the holdouts would have to own all of it and that's simply not the case," the source said.”

(emphasis added)

Again, it appears to us that it is actually immaterial whether or not the holdouts have positions in CDS. Argentina's government is attacking a straw man, to detract from the fact that it knows very well that it is bound by contract to pay its debts, and that the holdouts are acting perfectly in keeping with the law (more on this further below). It does not matter whether the bondholders are so-called “vulture funds”, there is nothing unlawful in what they are doing. It is quite astonishing that a deadbeat debtor keeps blaming his creditors for his own profligacy and unwillingness to pay (yes, unwillingness, not inability, in this case).

Argentina's government also keeps heaping blame on the mediator, who presumably tries to stick to the letter of the law and – we are just guessing here of course – refuses to adopt the government's creative reinterpretation thereof.

“U.S. District Judge Thomas Griesa said last week Argentina must continue negotiations with mediator Daniel Pollack to reach a deal with holdouts. Argentina's Cabinet Chief Jorge Capitanich on Monday reiterated its criticism of the lawyer.

"We consider he has been incompetent.. that he has been manifestly partial and definitively does not fulfil the role a mediator should," Capitanich said in his daily briefing.

Griesa later on Monday came to Pollack's defense with an order stating that he confirms his position to remain the mediator in the case and that removing him would be a gross injustice and drastically interfere with the discussion process which he wants to continue.

"He (Pollack) has been even-handed in relationship to the parties. There has been no bias in any degree," Griesa said.

This default strikes a contrast to the last one in 2002, which occurred during an economic and financial meltdown that plunged millions into poverty and saw dozens killed in riots. While Latin America's No. 3 economy entered a mild recession at the start of 2014, its banks are sturdy, the state is solvent and the streets of Buenos Aires are calm.”

(emphasis added)

Alejandro Vanoli,  president of Argentina's market regulator Comision Nacional de Valores , the authority now tasked with a faux “investigation” into the holdouts

The Propaganda-Free Reality

Before showing why Argentina's government is definitely not a “wronged party” in these proceedings, we want to reiterate that there is something slightly distasteful in buying government debt, since its owners must perforce rely on the State's powers of coercion and compulsion to receive their interest payments and get their money back. Moreover, those buying it are consciously taking an enormous risk and shouldn't be surprised if that risk one day becomes manifest.

As Ludwig von Mises noted, long term government debt is a “foreign and disturbing element in the structure of a market society”. It should furthermore be crystal clear that governments actually cannot pay it back, and certainly have no intention of ever doing so. Those who lend to governments are also withholding their savings from the funding of more worthy endeavors. In Mises' words:

The long-term public and semi-public credit is a foreign and disturbing element in the structure of a market society. Its establishment was a futile attempt to go beyond the limits of human action and to create an orbit of security and eternity removed from the transitoriness and instability of earthly affairs. What an arrogant presumption to borrow and to lend money for ever and ever, to make contracts for eternity, to stipulate for all times to come!

Nobody believes that the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract.

A host of sophisticated writers are already busy elaborating the moral palliation for the day of final settlement.”

(emphasis added)

In a footnote, Mises also addresses the absurd notion that the public debt is allegedly no burden because “we owe it to ourselves”. There are only two ways of dealing with public debt: either those producing wealth must be taxed for the benefit of bondholders, or the debt is repudiated one way or another. Although Mises doesn't mention it explicitly below, this act of repudiation can also involve massive monetary inflation, one of the ways in which debt repayment can be achieved while clearly violating the 'terms of the contract', at least in spirit, if not de iure.

“The most popular of these doctrines is crystallized in the phrase: A public debt is no burden because we owe it to ourselves. If this were true, then the wholesale obliteration of the public debt would be an innocuous operation, a mere act of bookkeeping and accountancy. The fact is that the public debt embodies claims of people who have in the past entrusted funds to the government against all those who are daily producing new wealth. It burdens the producing strata for the benefit of another part of the people. It is possible to free the producers of new wealth from this burden by collecting the taxes required for the payments exclusively from the bondholders. But this means undisguised repudiation.”

(emphasis added)

Now let us briefly consider why Argentina's government is definitely not a wronged party. First of all, it does not matter one whit who currently owns the debt. The fact that several of the holdouts are so-called “vulture funds” is completely immaterial, since Argentina issued bearer bonds. Whoever purchases them in the secondary market “inherits” all the legal clauses attached to them that are supposed to protect creditors.

Whether the original lenders were different people or entities that have sold the debt and moved on simply does not matter. Obviously, the only reason why the government keeps invoking the “vultures” is because it hopes to gain sympathy for its position, but sympathy is not a legal concept.

To see why the government keeps losing the court cases against the hold-outs, here are a few excerpts from anarticle by Nicolás Cachanosky written prior to the default, that explains the historical and legal backdrop (h/t Steve Saville). First of all, the introduction of a currency board made it impossible for Argentina's government to let its central bank monetize government debt (it has of course resumed doing so in the meantime). However, the government still came up with scheme to remain as profligate as ever. Moreover, given the historically well documented unreliability of Argentina's government as a debtor, the government voluntarily accepted that New York courts would rule on any disputes with creditors and imbued its bonds with clauses that provided extra protection to bondholders.

Cachanosky writes:

“Due to the Convertibility Law during the 1990s, Carlos Menem’s government could not finance the fiscal deficit with newly created money. So, rather than reduce the deficit, Menem changed the way it was financed from a money-issuance scheme to a foreign-debt scheme. The foreign debt was in US dollars and this allowed the central bank to issue the corresponding pesos.

The debt issued during the 1990s took place in an Argentina that had already defaulted on its debt six times since its independence from Spain in 1816 (arguably, one-third of Argentine history has taken place in a state of default), while Argentina also exhibited questionable institutional protection of contracts and property rights. With domestic savings destroyed after years of high inflation in the 1980s (and previous decades), Argentina had to turn to international funds to finance its deficit. And because of the lack of creditworthiness, Argentina had to “import” legal credibility by issuing its bonds under New York jurisdiction. Should there be a dispute with creditors, Argentina stated it would accept the ruling of New York courts.

These New York-issued bonds of the 1990s had two other important features besides being issued under New York legal jurisdiction. The incorporation of the pari passu clause and the absence of the collective action clause. The pari passu clause holds that Argentina agrees to treat all creditors on equal terms (especially regarding payments of coupons and capital). The collective action clause states that in the case of a debt restructuring, if a certain percentage of creditors accept the debt swap, then creditors who turn down the offer (the “holdouts”) automatically must accept the new bonds. However, when Argentina defaulted on its bonds at the end of 2001, it did so with bonds that included the pari passu clause but which did not require collective action by creditors.

Under the contract that Argentina itself offered to its creditors, which did not include the collective action clause, any creditor is entitled to receive 100 percent of the bonus even if 99.9 percent of the creditors decided to enter a debt swap. And this is precisely what happened with the 2001 default. When Argentina offered new bonds to its creditors following the default, the “holdouts” let Argentina know that under the contract of Argentine bonds, they still have the right to receive 100 percent of the bonds under “equality of conditions” (pari passu) with those who accepted the restructuring. That is, Argentina cannot pay the “holdins” without paying the “holdouts” according to the terms of the debt.

The governments of Nestor Kirchner and Cristina Kirchner, however, in another sign of their contempt for institutions, decided to ignore the holdouts to the point of erasing them as creditors in their official reports (one of the reasons for which the level of debt on GDP looks lower in official statistics than is truly the case).

It could be said that Judge Griesa had to do little more than read the contract that Argentina offered its creditors. In spite of this, much has been said in Argentina (and abroad) about how Judge Griesa’s ruling damages the legal security of sovereign bonds and debt restructuring.

The problem is not Judge Griesa’s ruling. The problem is that Argentina had decided to once again prefer deficits and unrestrained government spending to paying its obligations. Griesa’s ruling suggests that a default cannot be used as a political tool to ignore contracts at politician’s convenience.

(emphasis added)

In other words, all the sanctimonious complaining about “vultures” and the faux  “investigation” into whether the holdouts have bought CDS is in the end not much more than further proof of the Argentinian government's barely disguised contempt for property rights and institutions.

Let us not forget, this is the same government that simply expropriated YPF-Repsol, eventually fobbing off the former owners with half of its value after two years of litigation, regards foreign mining companies that have invested hundreds of millions as “sitting ducks” whose properties can be stolen under all kinds of flimsy pretexts, has instituted a “Zwangswirtschaft” with all kinds of state control over the economy, complete with multiple restrictions of trade and foreign exchange dealings and is inflating its currency into oblivion. Its inflationary policy has the additional twist that the government is blatantly lying about the currency's loss of purchasing power, while threatening economists who dare tell the truth with fines and even imprisonment. To say that these crypto-fascists are not trustworthy would be quite an understatement.

Conclusion:

“Vulture funds” actually fulfill a valuable function, just as other speculators do. In this case, their willingness to take Argentina's government to court and the court's insistence to stick to the letter of the law, actually produces benefits for all other emerging market economies. As Mr. Chachanosky inter alia correctly states, if the court had let Argentina get away with welshing on its debt to the holdouts, it would have resulted in making it much more difficult for emerging market countries in general to attract foreign funding. If governments are allowed to get away with ignoring the terms of their bond contracts and are enabled to stiff their creditors at will, borrowing will become very difficult and costly.

Another potentially salutary effect is that the profligacy of Argentina's government may be stopped dead in its tracks. This would be highly beneficial to all of Argentina's citizens, who have been burdened by run-away inflation and extreme restrictions of economic liberty. No-one should fall for the Argentine government's propaganda.

The Argentine peso, daily, via investing.com. We have pointed out on several previous occasions that the peso's chart suggested a further decline in the currency's external value was highly likely. This assessment has turned out to be correct – recently, the decline has been accelerating again. It is even more pronounced in terms of the black market rate