The failure of debt-based development: lessons from Argentina.

• Author: Bruno, Eugenio Andrea

In this article I discuss the lessons one can learn from Argentina's recent debt restructuring and the possible rules and practices of future restructurings. But I will also briefly describe the long and extremely problematic Argentine debt history, which started in 1824, to show the failure of the debt-based economic development model. I conclude that, regardless of any pyrrhic victory obtained from the restructuring process and the willingness of the international financial markets to lend new money, Argentina should not incur additional public debt.

Lessons from the Restructuring Process

Legal Inclination toward Sovereign Debtors

The overall rulings of the U.S. courts regarding the numerous claims filed by bondholders against Argentina have so far favored the sovereign debtor. Even though the U.S. courts have issued various judgments against Argentina, there has not been any effective enforcement of those judgments. The U.S. courts have always found a way to reject all legal arguments presented by the holdouts, so bondholders have so far not been able to collect on their judgments. For example, in one of the latest attempts by the holdouts to attach assets (filed after the bonds were tendered by the bondholders but before the exchange offer was implemented in early 2005), the U.S. Court of Appeals for the Second Circuit, on May 15, 2006, did not rule in favor of Argentina on legal grounds but rather on political considerations. The judges, in E. M. Limited v. the Republic of Argentina, said that the exchange offer was necessary for Argentina's well being, and for that reason they confirmed the judgment from the district court. In Argentina the Supreme Court ruled against the rights of the bondholders to collect in accordance with their original terms, arguing that the existence of an emergency justified limiting property rights.

From the foregoing, it appears that (1) the level of actual protection given by New York law and jurisdiction regarding sovereign bonds is not sufficient to protect creditor rights, and (2) Argentine courts too often accommodate the needs of the government rather than the private property rights of citizens.

In Europe the luck of the holdouts has been no better than in the United States. The Italian courts have rejected the claims filed by the Italian bondholders, and the German courts have not condemned Argentina, giving the government precious time to advance with the restructuring proposal.

Another interesting aspect of Argentina's restructuring process is that the favorable reaction from the courts had the support of the clearinghouses of debt-related securities and other financial institutions. The clearinghouses, in particular, are agencies of crucial importance because they are the places where eventual attachments against Argentina's assets might materialize. For instance, the Belgian parliament--with jurisdiction over Euroclear, one of the principal European clearinghouses--approved a law to exempt Euroclear from possible attachments from holdouts of payments made by Argentina and its agents.

Argentina's favorable treatment from the courts was not anticipated because in the recent past the courts had usually protected the rights of creditors. Today holdouts do not appear to have weapons powerful enough to threaten sovereign debtors or to affect the restructuring process. Of course the saga has not ended, and the holdouts still might try to attach the proceeds of new debt securities issued in the international capital markets or some other asset, and eventually may succeed in the long run. But if recent history is any indication, the courts may keep the future balance in favor of sovereign debtors.

Are Statutory Mechanisms Needed to Regulate the Restructuring?

The lack of success of the holdouts to collect on their judgments brings into question two important purposes of the sovereign debt restructuring mechanism (SDRM) promoted by the International Monetary Fund: (1) avoiding attacks from the holdouts against the restructuring when it is occurring, and (2) giving debtors the possibility...