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| Argentina's
Bond Swap Deal Is Smoke and Mirrors  David
DeRosa, president of DeRosa Research & Trading, is an adjunct finance professor
at the Yale School of Management and the author of ``In
Defense of Free Capital Markets.'' The opinions expressed are his own.
We should have seen this coming, because it's the oldest trick in the book of finance. If you can't pay today, ask your creditors to allow your loans to be extended. They might go for it, not because they want longer-term paper (in fact, they probably would prefer to get out of Argentina entirely), but because by accepting your offer, they can avoid the appearance of default. And that is the heart of the matter. The unusual aspect is that Argentina appears to want to make the bond swap a voluntary program for some $20 billion in bonds. Voluntary means that no bondholder is being visibly forced to trade his or her paper for long-term bonds. There might even be some kind of premium, or sweetener, tossed in to create an appearance that the swap deal was not coercive. But voluntary? I don't think so, because the consequences of a bondholder's refusal to go along with the deal would be brutal. Currency and Debt As of now, Argentina has two financial pressure points. One is whether the government will be able to avoid default. The other is whether it can keep the peso pegged to the dollar. The two are not independent of each other. Losing the peg for the peso could trigger a government default on its bonds. The government has borrowed heavily in dollars as well as in euros. The peso value of this debt would skyrocket if the peso were de- pegged in the midst of this crisis. The government could well become insolvent if the currency cracks. But it could well work the other way in terms of causation. Argentina pegs the peso to the dollar under the auspices of a currency board. The board holds dollars and dollar-based assets equal in size to the outstanding supply of pesos in the hands of the general public. It has an obligation to exchange one peso for one dollar. If Argentina defaulted on its debt, there would be a ferocious run on the peso, currency board or no currency board. Since the currency is more or less fully backed by the reserve in dollars, the question would become not whether the government would have the wherewithal to withstand the onslaught of peso sellers but rather whether it would keep the will to do so. Dollars would flow out of the currency board as pesos were turned in for hard currency. At some point, government would be forced to decide between keeping its hard currency assets and maintaining the foreign exchange regime. There is an ominous precedent with Russia in 1998. Though Russia did not have a currency board at the time, it did peg the ruble to the dollar, with some allowance for small up and down movements in foreign exchange trading. In August, when Russia defaulted on its maturing Treasury obligations, the Central Bank found it impossible to maintain the peg on the ruble because everyone inside and outside Russia wanted to dump the ruble. Domestic companies and institutions in Russia, having borrowed heavily in dollars, needed to hedge by buying dollars and selling rubles. Foreign investors, having bought Russian debt in the form of derivative instruments and structured products, rushed to sell so as to cut their exposure to the ruble. The lesson of Russia is that when the government defaults on its debts, the currency heads south, big time. Virtual Nastiness With this as background, one could see why holders of Argentine bonds might want to cut the government some slack in order to avoid a formal default. For its part, I can imagine the government will spin its swap proposal by saying there is a need to give Argentina some breathing room. When conditions return to normal, whatever that might mean, the government will be more liquid as the economy improves. Until then, Argentina needs time. It is a very seductive argument. It reminds me of the story that Malaysia put out after it imposed capital controls in September 1998. At that time it was suggested that all Malaysia needed was a little breathing room, a hiatus from the judgment of the foreign exchange market, so that it could put its house in order. How is that every time some country asks for breathing room its investors get the wind knocked out of them? So I am going to call this for what it is. The Argentine bond swap, though not technically a default, is in fact a virtual default. |
