Nouriel Roubini on Argentina's deal with its creditors. [I corrected a couple of typos.]
Julio * * * The Successful End of the Argentine Debt Restructuring Saga... by Nouriel Roubini Last January, on the eve of the launch of Argentina's debt restructuring proposal, many market participants, pundits and commentators predicted that the offer would fail as a large 70% haircut would be unacceptable to most creditors; this, in spite of the fact that the market prices of Argentina's defaulted debt had been hovering around 30 cents on the dollar for quite a while in 2003-2004, suggesting that this was the true equilibrium value of such debt. At that time I predicted in a blog item I wrote on January 11th (http://www.roubiniglobal.com/archives/2005/01/argentinas_debt.html) that a rational analysis of the facts would lead to the conclusion that the debt deal would instead be successful with about 75 to 80% of creditors accepting the offer. While the official figures will be out later today Thursday (http://www.reuters.com/financeNewsArticle.jhtml?type=bondsNews&storyID=7788460), most media and market reports now suggest that the deal will indeed be successful with a participation rate of about 70 to 80% (http://www.reuters.com/financeNewsArticle.jhtml?type=bondsNews&storyID=7778675). The last few weeks confirmed my predictions but have also been interesting for the press coverage and market commentary on the deal. As I had then predicted, most institutional investors, hedge funds and other savvy investors (over 90% of them it appears now), as well as almost all Argentine creditors (over 90% of them) and large parts of the retail investors accepted the deal. I argued that the main resistance would come, as it did, from the Italian retail investors. Even that latter group, eventually, gave up and sold in droves their claims to hedge funds and other investors, that then accepted the deal. As predicted, savvy market investors behaved rationally and realized that holding out was a losing strategy. It was even a more losing strategy for the retail investors who, in large part, capitulated at the end. Most Wall Street and financial community commentary on the deal - especially on the research and sell side - was fair, sensible and devoid of the shrill tone of some of statements of the organized creditor groups (namely GBAC, ABRA, and the various organizations representing the Italian retail investors). This commentary and behavior of most investors proved that folks in financial markets are smart, savvy and rational investors. Press commentary on the deal was less stellar. The Financial Times, usually a beacon of high quality and honest reporting and balanced commentary, had a coverage that was highly disappointing in this episode. First, the FT published a self-serving op-ed by Adam Lerrick (http://news.ft.com/cms/s/1c4c1944-633d-11d9-bec2-00000e2511c8.html) who, as the representative of ABRA (the "largest" creditor group representing S1.2b worth of claims of Austrian and German retail investors), had financial conflicts of interest galore (see below); his bashing of the IMF and Argentina was disonest, logically faulty and substantially incorrect, a dog's bark with no bite as the final capitulation of ABRA into accepting the debt offer proved (http://www.bloomberg.com/apps/news?pid=10000086&sid=a6dC6HXJ4VRg&refer=latin_america). Then, responding to my blog complaining about Lerrick's self serving junk, the FT asked me to write a rebuttal op-ed. But then, the FT sat on it for three weeks without even the courtesy of informing me of the rejection. In the meanwhile, the FT wrote an editorial bashing Argentina for its proposed deal, an editorial that was a direct step by step rebuttal of my proposed op-ed arguments without even having published such arguments in the first place. Moreover, the FT daily reporting on the deal - mostly by Adam Thomson - was clearly biased in favor of GBAC (the umbrella group of creditors of which ABRA is part of) and of those opposing the deal, with little or no presentation of counter-views. And no other oped - apart the self-interested junk written by Lerrick - was published by the FT on the most important debt restructuring in history; so much for balanced and fair commentary. Finally, when last Sunday ABRA decided to capitulate and accept the deal, the FT put this minor event as its lead story on the front page on Monday (http://news.ft.com/cms/s/168f3320-890c-11d9-b7ed-00000e2511c8.html)without even pointing out the basic and simple reason why Lerrick and his gang had accepted the offer: that they would make millions and millions of dollars in fees (at extortionary rates for their creditors) without delivering any value whatsoever to the creditors they represented. These creditors got the deal that everyone else did and ABRA's services were worth literally zero. So, Lerrick and his gang would have accepted the deal even if it had been 10 cents on the dollar rather than 30; their private financial interest was exactly orthogonal to that of the creditors they represented. I.e., pocketing millions to the expenses of hapless creditors without providing any service or benefit, while formally barking in public for weeks against Argentina and the IMF. What a pathetic greedy hypocrisy. You would have thought that the FT would have pointed out to its readers this basic fact rather than repeating the pathetic self-serving excuses brought by Lerrick to justify ABRA's last hour capitulation. But there was not a single word of that in the FT in spite of the fact that in January Michael Casey of the Dow Jones had bravely reported (see his story reported below) that Lerrick and his gang had major conflicts of interest and in spite of the fact that this has been known for ages in the financial and policy community. So kudos to Micheal Casey for his brave reporting and shame to the FT for a reporting and commentary biased to the views and interests of this group of financial con artists. In the meanwhile, the Italian organizations representing the retail creditors took a confrontational posturing that was also self-serving: the banks and financial institutions that had ripped-off such retail creditors in the first place - by dumping the Argie bonds on unsuspecting and clueless small savers - were now paying for these creditors organizations costs' and "represented" these retail creditors: it is like hiring as your lawyer for a robbery case the very robber who had stolen your money. These banks now cared only about the legal risks of being sued by such retail creditors for their "aggravated deceit" and found it more convenient to refuse a deal that made total sense for such retail investors, just to cover their own asses and minimize the risk of being now sued for their initial malfeasance. So, all this posturing was not aimed at the best interests of the retail investors but rather at avoiding litigation against the banks. It was beneficial for these banks and institutions to pretend that they would refuse a "bad" deal that was "unfair" to retail investors even if that deal was instead fair and the best one that such investors will get, only to avoid the risk of being sued down the line for the risk of not having "toughly fought" for the rights of such investors. All this, in spite of the fact that this self-serving posturing and rejection of the deal now means that these holdout retail investors will be ripped off a second time by holding illiquid and worthless defaulted claims. Then , the poor retail investors, sensing that the organizations "representing" their "interests" were out to get them a second time, responded by selling in the market - before the deadline of the deal - billions of such claims to hedge funds and other savvy investors. Given that these claims were in small individual quantities, such small desperate retail investors got prices for such a fire sale that were well below the current market prices of Argie's debt. So, those retail investors who wanted to avoid being ripped off again by their own creditor organizations ended up taking further losses to avoid being stuck in the consequences of the dishonest and self-serving rejection of the deal by the organizations alleged to represent them. If such organization! s had instead accepted the deal, the losses from the fire sale of billions of dollars of claims by retailers to hedge funds (who happily pocketed this arbitrage differential) would have been avoided. So, thank you Mr. Nicola Stock (co-head of GBAC and "representative" of the Italian retail investors), another self-serving con artist, for ripping off again the retail investors whose interests you were supposed to represent. We wish that some of the investors that you so well "represented" will use their remaining resources to sue you rather than suing Argentina. So, the "aggravated deceit" legalese that Stock is now using threaten to sue Argentina is not Argentina's deceit; it is the Aggravated Deceit by Stock and his gang who should be sued by retail investors for failing to make decisions in the interest of such creditors rather than the rejection that is in the legal interests of the Italian banks. And you would have thought that the FT or some other serious media outlet would have fairly reported and analyzed the biases and self-interest of such individuals and the institutions behind them but not a single word was written by the FT or anyone else in the press about it. So much for accurate and insightful reporting. At the end, the debt deal was successful in spite of the FT, Lerrick, Stock and company for the simple reason that rational market agents behave rationally and according to economic logic and best self-interest. In the meanwhile, Paul Blustein of the Washington Post has published a fascinating book - "AND THE MONEY KEPT ROLLING IN (AND OUT: Wall Street, the IMF, and the Bankrupting of Argentina" (http://www.amazon.com/exec/obidos/ASIN/1586482459/qid=1109852722/sr=2-1/ref=pd_bbs_b_2_1/104-9363104-7755121) - that provides an excellent post-mortem of the Argentine crisis even if it does not cover the debt restructuring deal. This is a first rate, very well researched and gripping account of the causes of the Argentine crisis and the events and background that led to the default and collapse of the currency board. Thus, a very good follow-up to Blustein's The Chastening, his earlier book and tale of the Asian crisis. With the default behind it - we will get back to the issue of the remaining holdouts soon - what are the lessons one can learn from this episode? Some worry that the behavior of Argentina means that now defaulting and getting large haircut has become much easier. This argument has no merit. Is default easy or costless? Argentina had do go through a most severe crisis with output falling by over 25%. Even today after two years of high 8% growth, the real GDP of Argentina is barely back to the 1999 level (and still much lower in dollar terms) that it had before the recession that preceded the eventual crisis. Argentina lost 6 years of growth, had massive social and economic pain with poverty and unemployment rates through the roof. And all this would mean that default is costless and that other countries will rush to default like Argentina did? Utter non-sense. Lula, as soon as he was elected, looked across its border and saw what default - even an unavoidable one like Argentina's - causes as its by-product, i.e. massive crisis and pain. And he rightly decided to do even more fiscal adjustment and try to avoid default. The lesson of Argentina is that crisis and default are very costly and painful, not that they are costless. Otherwise, if default is so costless, how come we do not see dozens of highly indebted countries following Argentina and defaulting? And if everyone has an incentive to default costlessly, and this creates opportunistic-default moral hazard distortions, how come EM sovereign spreads are close to historic lows? Based on the current low spreads, one can infer that Argentina's current deal and haircut has not affected at all the average probability of default for EMs, nor it has affected in any way the expected recovery values (or expected losses/haircuts given default). Market spread for EMs completely disprove the argument that default is easy, costly, more likely and more likely to lead to larger haircuts in the future. As for the upcoming negotiations between Argentina and the IMF for a resumption of its economic program, all sides should start having a constructive attitude, avoid posturing and try to work together to get a resumption of the IMF program that will be necessary and beneficial to all. Argentina should avoid gloating and take a less confrontational attitude towards the IMF. Argentina will need to maintain at least a 4% of GDP primary surplus to service its stock of restructured public debt; so it should agree to such fiscal target with the IMF. Argentina also needs to maintain fiscal discipline to avoid further debt build-up and to be able to rollover the domestic bonds coming soon to maturity. It needs to continue structural reforms (co-participation reform, a constructive resolution of the utility tariffs issues, further work to clean up the banking system) to ensure the new investment in capital goods that is necessary to avoid capacity bottlenecks and other constraints to sustained long term economic growth. It should also take a constructive attitude towards holdouts - many of which are hapless retail creditors that were poorly served by the organizations supposed to defend their "interests" - by reopening the deal for a short period of time and offering the same debt deal to the holdouts; a last chance for them to accept the deal. So, one hopes that Argentina will continue with its sound fiscal and monetary policies, accelerate structural reforms and try to get the holdouts to accept the original deal rather than maintain a tough stance on this matter. As for the IMF, it is clear by now that the US Treasury lasseiz-faire and hands-off approach to crisis resolution, that has been forced on the IMF since 2001, has been an utter failure. Its main architect, the U.S. Under-Secretary John Taylor, will be soon gone (and hopefully he will not get any other new top international financial institutions leadership assignment). One would hope that the new U/S Tim Adams will be a little more humble and savvy and listen to some intelligent economists, to the IMF and to his own staff when deciding how to approach crisis resolution. Some humility from the US Treasury on crisis management/resolution is most necessary. The IMF made his own honest and intelligent "mea culpa" on Argentina with the IEO report, the Board discussion of this report and the staff (PDR and response to the IEO) and management assessment of what went wrong in Argentina. The IMF has learned his lessons as a mature and essential institution that will remain central to crisis resolutiom. Instead, the US Treasury never even aknowledged any mistake in its handling of Argentina and the crisis; no reassessment, let alone a mea culpa, at all. As Paul Blustein's book shows, the Bush administration and the US Treasury utterly failed in its handling of the crisis, at every step of the way with O'Neill and Taylor and a clueless political White House as the main culprits. And the US Treasury has now become a shadow of its own glorious past with repeated mediocre leadership and utter demoralization of a smart, hard working and devoted staff. So, Mr. Adams: please listen carefully, read attentively, study a lot and be humble before you talk about emerging markets, crisis resolution, the IMF, the dollar, China, the US twin deficits and the risks that they imply for a hard landing of the US and global economy (see my recent paper with Brad Setser at http://www.stern.nyu.edu/globalmacro/BW2-Unraveling-Roubini-Setser.pdf). The last four years of ostrich-like and inept attitude by the top brass of the US Treasury towards international financial policy making needs to change now. Given the risks and dangers in the global economy we cannot afford another four years of mediocre policy making. That starts with the US Treasury attitude towards Argentina's upcoming negotiation with the IMF. The US Treasury and the IMF, as well as Argentina, should take a constructive, conciliatory and positive attitude to the coming challenges. They should aknowledge that the deal was very successful while nudging Argentina to reopen the same deal to holdouts. While the IMF should fairly suggest that Argentina should continue and lock-in formally its sound fiscal and monetary policies while accelerating structural reform, it should not take a tough stance on the debt that is still in default. The US Treasury should also avoid any posturing on this issue and on the issue of the pace of structural reforms, and it should aknowledge the economic and policy progress that Argentina has made so far. All sides should sit down and constructively agree on resuming the program without tough positions and posturing. The Argentine crisis and debt deal also offer some sobering lessons on how not to resolve crises. You do not need an SDRM, not even collective action clauses (CACs) to get a debt deal done, as I have argued for years in my writings and recent book with Brad Setset (http://bookstore.iie.com/merchant.mvc?Screen=PROD&Product_Code=378). CACs are nice and useful but not essential. And you do not need negotiations to get a deal done. The current system of unilateral debt exchanges works and it should not be changed as it is not broken. All previous debt restructuring deals were done without negotiations between the debtor and its creditors. In a typical deal - Pakistan, Ukraine, Ecuador, Uruguay and now Argentina - the debtor never negotiates: it hires a legal advisor and a financial advisor who do some extensive market soundings - not negotiations - to figure out which deal is acceptable to a large fraction of creditors. Then, when the homework is done, the country makes an exchange offer, i.e. a take-it-or-leave-it debt exchange. And in all cases before Argentina, 99% of creditors accepted the offer and there were very few holdouts. Argentina behaved in the same fair way: it did its market soundings and then made an exchange offer. Yes, some extra info sharing and consultation by Argentina with its creditors would have been nice and fair but it would have not changed the substance of the eventual deal. Again, it was delusional for many investors to believe otherwise. Savvy and sophisticated investors - a large part of the EM asset class creditor base - knew all along that there would be no negotiations, neither on the terms of a deal nor (an even more far fectched and non-sensical idea) on the terms of a macroeconomic adjustment package (as no self-respecting country will ever negotiate its macro plans with its creditors; that is why the IMF exist, to negotiate as a public instituion such program terms). The US Treasury, with its lasseiz-faire and hands-off policy, was the primary driver of this massive mass delusion, making some creditors believe that they would sit down and negotiate an economic plan and the terms of a deal with the creditors: what a foolish delusion to feed to creditors. I indeed recollect an AEI conference exactly (http://www.aei.org/events/filter.,eventID.767/transcript.asp) a year ago where the IMF, US Treasury and the private sector were all repeating the same exact broken and flawed tune: "the official sector should take an hands-off approach and Argentina should sit down and negotiate with it creditors; negotiations, negotiations, negotiations!" There, they all sang the same exact broken and flawed record: Humes (GBAC), Lerrick (ABRA), Calomiris, Quarles (US Treasury), Krueger (IMF). And hearing the IMF, that only a year earlier had pushed so hard for the SDRM (the institution where the IMF would be deeply involved and in command of debt default resolution) now sing the same flawed song of lasseiz-faire, hands-off and negotiations made me wonder of which kind of intellectual schizophrenia the IMF was suffering: pushing one year for the SDRM where the IMF is in charge of all and the next year pushing for no involvement at all. As Ted Truman and myself argued at that AEI panel, such hands-off approach was faulty and the wrong way to manage crises. The IMF, not the creditors, should be in charge of negotiating a multi-year macro program. The IMF and the G7 should be deeply involved - not detached - in managing a crisis and offer carrots in additions to sticks when negotiating a deal: the country commits to a serious program but it also receives some modest new net financing (for example, a couple of billon dollars to have a cash sweetener on the table once the offer is made) and some debt relief on its Paris Club debt (as the new Evian framework now allows Paris Club debt reduction for middle-income highly indebted countries such as Argentina). The IMF should also provide a debt sustainability analysis that frames the possible deals that achieve medium term debt sustainability, thus helping creditors to get a reality check rather than inisist on delusional demands for a deal worth 65 cents on the dollar, a request that was totally unsustainable. Such debt sustainability analysis would have been beneficial also for creditors by showing that, under some scenarios, the country could afford to pay a little more than 30 cents on the dollar. But the US Treasury ideological zealotry on lasseiz-faire and hands-off prevented the IMF from doing its job and needlessly delayed a deal that did not require three years to be achieved. In this context, some modesty and realism on the proposed code of conduct and principles for crisis resolution is also necessary. A code will always be of limited use as it demands too much from the debtor and puts almost no constraints on rogue creditors. Consultations, information provision, enhanced engagement with creditors are all fine; negotiations, tight linkages of principles with IMF lending into arrears policy are not fine. So, it is now time to learn the right lessons of this crisis and its resolution, let bygones be bygones and start to have a new and more constructive approach to crisis resolution devoid of "free market" zealotry. Hopefully, the US Treasury has learned something by now from it own dismal policy failures, even if it has so far avoided the necessary public mea culpa on the crisis and on its inept management of it before the Argentine default in 2001 and after it. If the IMF had the intellectual honesty and maturity to do that intelligent and thoughtful self-assessment, one would expect that the U.S. Treasury - its political master who had a most central role in this failed policy - would also aknowledge its failings in this disaster. That would be a good starting speech for Mr. Adams in his new Under Secretary for International Affairs role, a good tabula rasa from which to start rethinking the crisis resolution approach. For some lessons, suggestions and ideas, he may want to! Take a look at Paul Blustein's book and my new book with Brad Setser (http://bookstore.iie.com/merchant.mvc?Screen=PROD&Product_Code=378).
