Martin Wolf: Defend Argentina from the vultures
Opinion: mechanism to restructure sovereign debt is not optional in global capitalism
A pro-government activist throws a firework at policemen guarding the US embassy in Buenos Aires, during a protest against the US court ruling about “holdout” investors in Argentina. Photograph: Reuters/Enrique Marcarian
Not far from the London offices of the Financial Times was the Marshalsea prison where debtors were sent. In the 18th century, more than half of London’s prisoners were incarcerated for undischarged debt. The moral hazard Taliban of the day insisted that such harsh penalties were necessary. Then, in 1869, imprisonment for debt was abolished and bankruptcy introduced. Both economy and society survived.
Things sometimes go wrong. Sometimes due to bad luck and sometimes irresponsibility. But society needs a way to allow people to start over again. This is why we have bankruptcy. Indeed, we allow the most important private actors in our economies – companies – to enjoy limited liability. This lets shareholders walk away from their companies’ debts unscathed. That idea, too, was condemned as a licence for irresponsibility when introduced. Limited liability does bring problems, notably in highly leveraged businesses (such as banking). The ease with which US corporations can walk away from their creditors is breathtaking. But this is better than unlimited liability.
A similar logic applies to countries. Sometimes their governments borrow more than they can afford. If they have borrowed in domestic currency, they can inflate their debt away But if they have borrowed in foreign currency, that possibility disappears. Usually, it is countries with a history of fiscal irresponsibility that find themselves obliged to borrow in foreign currencies. The euro zone has put its members in the same position: for each government, the euro is close to being a foreign currency. When the costs of servicing such debts become too high, then restructuring – default – becomes necessary. As Carmen Reinhart and Kenneth Rogoff of Harvard University showed in This Time is Different, this is an old story.
As I argued at the time, Argentina found itself in this position at the turn of the century. It was difficult to feel much sympathy for the country, which suffered from chronic mismanagement before its default in December 2001 and was to suffer yet more thereafter. But it had become impossible to service its public debt of $132 billion at tolerable cost. Moreover, creditors had been rewarded for the possibility of default. Even at its lowest point, in September 1997, the spread of Argentine dollar bonds over US treasuries was close to three percentage points. A creditor compensated for the risk of a default cannot be surprised by it. The solution is portfolio diversification.
While the principle of sovereign debt restructuring is compelling, in practice it is difficult. No court can seize and then liquidate a country’s entire assets. This legal limbo creates two opposing dangers: the first is that it is too easy for a country to walk away from its debts; the second is that it is too hard. The Argentine story illustrates both: confronted with an intransigent government, holders of 93 per cent of defaulted debt accepted exchanges for debt with a hugely reduced face value; but “holdouts”, who reject such an exchange, have blocked a clean resolution. The mess has lasted over 12 years from default.