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October 31, 2014

#ForeignAffairs

Monday, June 30, 2014

Financial history in the making

By Andrés Federman
For The Herald

Pope Francis, “Che” Guevara, Evita, Jorge Luis Borges, Diego Maradona, Lionel Messi. You choose the order of relevance but they are all Argentine names that left or are leaving a mark in our world’s history. But, beyond its contributions in terms of personalities, Argentina has other claims to fame. The country is not a world power. Possibly not even an emerging one. But the fact is that — at least in the world of global finance — it has managed and is still managing to unleash processes and debates that shape the way in which things happen and are done.

The Baring crisis back in 1890 was an interesting starting point. It was not the first foreign debt problem faced by the country. But what made that default special, is that it dragged the City into serious problems. Back in London, the Barings Bank had been recklessly greedy. It had floated the debt on behalf of the Argentine government. But the terms of the loan were so profitable to the lenders that — in order to maximize its gain — Baring had kept much of the Argentine bonds in its own vaults, instead of marketing them and, thus, spreading the risk. When Argentina defaulted, the inevitable happened. Barings faced a bankruptcy which would have — in turn — affected the rest of the City. The Bank of England could not — on its own — cope with the situation. So it had to ask for help from the French and Russian Central Banks to avert the crisis. An interesting footnote to this story. Back in 1995, Baring was — once again — facing terminal difficulties. This time on account of reckless speculation from Nick Leeson, one of its officials. Rumour has it that Barings’ authorities went to knock the Bank of England’s door to get help. And were told that “The Old Lady of Threadneedle Street” helps British Banks. But only one time. And Baring had already used that facility back in 1890.

Argentina contributed to world financial history again in 1956. Overwhelmed by its debts with official creditors Argentina asked for French help. Paris gathered the creditor governments, and an agreement with Argentina was reached in May, 1956. The Paris Club was born. As informal and quite loose organization with the mission of setting guidelines for, and dealing with, the difficulties faced by borrowing countries with their government creditors. Despite the fact the organization remains quite loose and formal (by comparison with, say, the IMF), it has developed quite comprehensive “rules of engagement” for creditor governments to deal with foreign debtors’ issues.

Then, in December 2001, Argentina set a new milestone. Under President Rodríguez Saá, the country defaulted on its foreign debt. It was an impressive figure, over US$100 billion, and considered to be the biggest default in world history. Argentina was in the midst of a terrible economic crisis. This perhaps explains the oddity of the country’s Congress welcoming this first formal declaration of bankruptcy with a cross-party standing ovation. It was Néstor Kirchner who — after becoming President in 2003 — started the long and protracted process of debt restructuring which included a substantial reduction of nominal amounts (“haircut” in the jargon). A vast majority of creditors (93%) entered the restructuring. The current conflict with the 7% holdouts is a last legacy of that process. And it has highlighted what seems to be a vacuum in international laws and regulations governing sovereign countries’ debt issued in, or under the jurisdiction of, the major financial centres.

In one of the statements it issued at the end of last week, the Argentine government made the US responsible for any damages caused by decisions of its Judiciary, namely Judge Griesa. So, if this happens, the US government faces a liability because of a decision from a Judge that is independent from both the US executive or legislative branches. Interesting concept in terms of international relations, especially because it follows that the government could be forced to twist a judicial court’s ruling, if it affects another country. What happens in this case with the judiciary’s independence? An interesting constitutional quagmire.

The other — obvious — question is about how much power is vested in the hands of a minority of creditors. In the case of a company seeking protection from its creditors, and offering a repayment scheme, a majority of — say 65% — approving the deal, makes it compulsory for all the creditors. This is not what applies with sovereign debt. Perhaps the time has come to protect the interests of the majority of sovereign debt creditors in a way similar to normal bankruptcies.

There is also the issue about the legitimacy of purchasing defaulted and devalued debt titles, with the sole purpose of collecting their full value in subsequent court actions. There is a strong body of legal opinion which says that such speculative operations should be definitely banned. This has to do not only with ethics but also with the practicalities of dealing with sovereign debt restructurings. In addition to G-77 + China, Mercosur and regional partners, a number of other voices are being raised in favour of Argentina’s position. They include the IMF, or top business publications like the Financial Times and The New York Times. It is not that they love creditors and investors less, but that they love a healthy international financial system more.

@andresfederman

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