Some countries default on their performing debt because they no longer have the ability to pay it. Other countries default on their performing debt because they no longer have the willingness to pay it. Argentina has been in both situations: something of a serial defaulter, it defaulted on or restructured its obligations in 1828, 1890, 1982, 1989, 2001, and 2005.
And it's going to default once again in 2013.
This time, however, is a little bit different. Argentina has both the willingness and the ability to pay its performing debt. It's adamant, however, that it's not going to pay $1.4 billion to Elliott Associates, a hedge fund which has been prosecuting a highly-aggressive litigation strategy against the country, based on the fact that it holds defaulted debt and refused to exchange that debt for performing bonds. Depending on where you sit, Argentina's refusal to pay off Elliott is either noble or foolish. But after two and a half hours of highly contentious oral testimony in federal appeals court today, it's pretty clear that the US courts aren't going to allow Argentina to stay current on its performing debt - not unless the country also writes a ten-figure check to Elliott. Which means that we're headed straight for default, with almost no realistic chance of avoiding it.
You didn't really need me to tell you that: one look at Argentina's 12-month credit default swap (current spread:5,266bp) will tell you everything you need to know. But this is a pretty big deal all the same - not least because the Second Circuit seems certain to hand down a judgment which is pretty bad law.
That's nothing new: in its first decision, the Second Circuit happily ignored lots of settled law about sovereign immunity, among other things, and was downright wrong about pari passu. This time around, the law preventing the Second Circuit from upholding the lower court's orders is much weaker, and mainly comprises something called Rule 65(d)(2)(C), which is even more obscure than pari passu. Essentially, the Second Circuit has proved itself more than capable of taking a steamroller to formidable legal obstacles; this one should present no real problems at all, by comparison.
The questioning was led, aggressively, by Judge Reena Raggi, who barely let a sentence get finished and who made it clear from the very beginning that she is if anything even more fed up with Argentina's antics than the district court judge, Thomas Griesa, whose verdict was being appealed. The fact that Argentina's vice president and economy minister were sitting right in front of her didn't faze her for one second: this was her courtroom, she was in charge, and it took her no time at all to accuse Argentina of being "contumacious". (Which is fair enough, even Argentina's counsel didn't really disagree on that front.) In Raggi's eyes, clearly, there's nothing worse than a contumacious defendant: it doesn't matter how many footnotes you have or how much precedent you cite, if you're thumbing your nose at her she'll find against you.
What's more, Raggi really doesn't like being blackmailed. Both Argentina and David Boies, acting on behalf of the bondholders who are currently being paid by Argentina, made the point multiple times that if Griesa's order was upheld, the certain result would be another Argentine default, a whole new set of cases on Griesa's docket, and, essentially, a loss for everybody, including Elliott Associates, which still wouldn't actually get paid. Raggi was unimpressed: "Is that really this court's concern?" she asked Boies, saying that it was not her job to wonder about "whatever the market might do" as a result of her ruling.
Boies, in truth, was unimpressive: he never seemed entirely on top of his brief, and there was one excruciating episode where he had to go scurrying off to ask Bank of New York's lawyer to find out the answer to a question which everybody else in the courtroom knew the answer to. Argentina's tactic today was to spend less time arguing its own case, and to outsource the job of fighting Elliott to Bank of New York and to David Boies, in the hope that they would be more sympathetic and less contumacious. But Raggi made mincemeat both of BoNY's lawyer - telling him in as many words at one point that he was giving very bad advice to his client - and of Boies, who was clearly out of his depth. Remarked one lawyer, observing the proceedings: "If you're going to bring in a hired gun, at least make sure it's fully loaded."
Argentina's own lawyer, Jonathan Blackman, started off rockily yet actually finished quite strongly, warning of the practical consequences of what everybody in the courtroom could quite clearly see coming at that point. "You're making it worse!" he said. "Do no harm!" It was an argument with no legal weight, and it won't change the final result. But he did give Argentina the use of a "don't say we didn't warn you" card at any time the US or anybody else criticizes it for defaulting yet again.
But the clear winner was Ted Olson, representing Elliott, who stayed calm and masterful throughout. In contrast to Boies, he knew exactly what he was talking about, was sure of the merits of his own case, and didn't feel the need to appeal to Learned Hand precedent every few minutes. In front of more impartial judges, he might have had a harder time of it. But oral arguments aren't the time or the place for jurisprudential nit-picking: that's what detailed briefs are for. Rather, Olson's job was to reassure the three appeals-court judges that they should feel perfectly comfortable upholding their colleague's decision and standing up for legal rights enshrined in New York-law documentation. And he did that extremely well.
Or maybe the real winner was pretty much everybody in the courtroom, since the one thing that seems certain is that the amount of litigation and dealmaking surrounding Argentine sovereign debt - which has already been enormous - is going to become positively stratospheric. It's hard to look too far into the future, here, but one likely scenario is that the appeals court will uphold Griesa's decision at some point in April or May, forcing a big default in June. At that point, Argentina will probably launch an exchange offer under Argentine law, under which anybody holding currently-performing bonds would be able to swap them into bonds with substantially identical terms, just payable in Buenos Aires rather than New York. Given that Argentine-law bonds have been trading at tighter spreads then US-law bonds for some months now, one can assume that nearly all bondholders would jump at the opportunity to keep on getting their coupons.
Argentina might even take the opportunity to give its holdouts a third bite at the cherry, offering them some kind of option to take a haircut and get performing Argentine-law bonds in exchange for their defaulted debt. But many holdouts would still remain, and will surely continue to pester New York courts for the foreseeable future.
All of which helps explain why Argentina's credit default swaps are trading so much wider than Argentina's bonds. The bonds will probably default, but bondholders are unlikely to suffer huge losses if they just have a bit of patience for a couple of months - eventually, Argentina will surely give them the opportunity to swap their debt into a slightly different instrument, one which is less susceptible to New York jurists. That said, the credit default swaps will be triggered, and Argentina will probably drop out of key emerging-market indices like JP Morgan's EMBI.
This is emphatically not what Argentina hoped for when it entered into its exchange offers in 2005 and 2010. Back then, the idea was that it could cure its default, mop up its holdouts somehow, or at least render them irrelevant, and ultimately make it back into the good graces of the international capital markets. Instead, Argentina remains a capital-markets pariah, it can't really do business anywhere in the world without worrying that Elliott or someone like it is going to attach its property, and pretty soon it will probably have to give up on issuing any foreign debt at all, retreating instead to its own small South American world.
Argentina is a unique and special case on many levels: the failure of its 2005 and 2010 debt restructurings does not mean that debt restructurings in general don't work, or that we need to resuscitate the idea of a sovereign bankruptcy regime. Still, the precedent being set here is not a happy one - not for international bondholders, probably not even for Elliott Associates, which is still a long way from getting paid, and definitely not for Argentina. This is looking very much like one of those court cases which absolutely everybody ends up losing.