Investors could sue the country for full repayment if debt restructuring discussions turn sour, and that’s when an expensive quirk of New York state law could become a big problem.
Argentina almost caught a big break this year from, of all people, Andrew Cuomo. Instead, the New York governor’s failed push to chop interest rates for debtors going through litigation could cost the serial defaulter billions of dollars.
The issue is at the fore as the nation holds intense negotiations to restructure US$65 billion of bonds following its third default of the century. While for now both sides want to continue talks, investors could sue the country for full repayment if discussions turn sour, and that’s when an expensive quirk of New York state law could become a big problem.
In the Empire State, unpaid debts that go to civil court accrue nine percent interest until the dispute is resolved, on top of whatever the original rate was. So-called "pre-judgment interest," which begins accruing once a breach of contract occurs, applies to unpaid rent or credit-card deadbeats, but the rule also snags sovereign borrowers.
The penalties Argentina could face if the battle becomes litigious are an incentive for the government to reach a settlement. More than US$50 billion of Argentine bonds are subject to New York law.
The country knows the pain of pre-judgment interest all too well. During 15 years of litigation in its last fight with bondholders, pre-judgment interest alone inflated Argentina’s tab by as much as US$2.1 billion, according to an estimate by University of Georgia professor Tim Samples, who co-authored a paper on Argentina’s 2001 debt restructuring.
“It could matter to the tune of billions – it sure did in Argentina’s last debt saga,” Samples said.
With warnings of defaults across developing nations as the Covid-19 pandemic upends economies, a lower rate on pre-judgment interest would have at the very least fortified the negotiating stances of borrowers at risk of getting sued.
It isn’t entirely clear why Cuomo’s change didn’t go through, though the idea of lowering interest rates has faced pushback through the years from creditors of all stripes. Cuomo’s proposed budget this year called for lowering pre-judgment interest to the going yield on one-year Treasury bills, currently 0.1 percent. That’s already the post-judgment rate, which is applied after a case is settled but before the debtor pays up.
When the legislature passed its 2020 budget in early April, the provision on pre-judgment interest was “intentionally omitted,” according to the document’s text. A spokesman for the state budget office, Freeman Klopott, said the proposal “would provide relief for local governments and lower costs for taxpayers.” When asked about why it didn’t go through, he said the enacted budget is “the product of negotiations with the legislature.”
A lawmaker in the assembly’s judicial committee says the removal had nothing to do with Argentina and he was never lobbied on the issue.
Instead, Assemblyman Tom Abinanti says that Cuomo’s team never made a good argument for the measure as lawmakers were flooded with coronavirus legislation. A Democrat like the governor, Abinanti says the proposed change quickly got cut.
“Argentina is collateral damage,” Abinanti said in an interview. “Nobody gave us a real reason why we should make this change or why it was urgent, why we can’t discuss it next year, so it fell by the wayside.”
Abinanti says legislators largely support keeping pre-judgment interest high to encourage debtors to pay. They also want to protect individuals who suffer physical injury and have to sue health-insurance providers for payment.
Pre-judgment interest was fixed at nine percent in 1981 when former Federal Reserve chairman Paul Volcker raised borrowing costs to stamp out inflation. But as most rates came down in the decades since, New York’s remained at nine percent.
Analysts say that if the dispute does go to litigation, Argentina is unlikely to pay the full nine percent tab. At the end of the day, it will be rolled into the settlement that presumably will be less than 100 cents on the dollar. But still, the high penalty incentivises creditors to let litigation drag on for years instead of striking a deal.
“The nine-percent pre-judgment rate is an invitation to litigate,” said Eduardo Levy Yeyati, an economist and founder of Argentine consulting firm Elypsis. “It’s something that the world’s financial architecture should address as soon as possible.”
It won’t come soon enough for Argentina, which finds itself unable to meet its obligations just four years after emerging from its last default and issuing billions of dollars of bonds. The country is suffering from a sharp drop in the value of its currency, inflation approaching 50 percent and is entering its third year of economic contraction, made worse by the pandemic.
Economy Minister Martín Guzmán, who is leading talks with creditors, called pre-judgment interest punitive in a 2016 academic paper before he was in government.
The high rate “punishes risky debtors twice,” Guzmán wrote. “They have to pay a high interest rate that includes risk compensation when they do not default and, on top of that, they have to pay nine percent per year after they default and until a judgment is reached.”
In recent days, Argentine bonds have climbed from record lows on optimism that a deal will get done. After bondholders panned an initial restructuring offer from the government, the country’s three largest creditor groups submitted counter proposals on May 15 and discussions are continuing. The bonds are now trading “flat” since the country defaulted, following a recommendation by the Emerging Markets Traders Association.
To Samples, the University of Georgia professor, the high interest rates during litigation create a distorting effect on negotiations, giving creditors an advantage they wouldn’t otherwise possess.
“If you’re a bondholder, depending on your strategy, you might want the debtor to default,” Samples said. “Nine percent? I mean who in the hell wouldn’t want that? Half of that would be extraordinary in today’s world.”
by Patrick Gillespie & Scott Squires, Bloomberg