Standard & Poor's on Monday revised its credit outlook on the United States government to stable from negative, citing Congress's avoidance of the year-end 2012 "fiscal cliff" and the higher-than-expected tax receipts that followed.

Additionally, the ratings agency, the only one to have cut the United States from the coveted AAA status, said it does not expect the debate later in 2013 regarding a raising of the debt ceiling to result in "a sudden unplanned contraction in current spending - which could be disruptive - let along debt service…."

The chances of a ratings downgrade is now "less than one in three" as improvements in tax receipts and economic performance are helping to bring down the country's debt levels.

S&P revises U.S. credit outlook to 'stable' from negative [Reuters]
Revived GM Welcomed Back Into the S&P500 [Bloomberg]

It sounds like yesterday's hearing was sort of a nightmare for Argentina, though the nice thing for Argentina is that, as a sovereign nation, they have the option of waking up:

“We are representing a government, and governments will not be told to do things that fundamentally violate their principles,” Jonathan Blackman, a lawyer for the deadbeat South American country, told a Manhattan US appeals court.

“So the answer is you will not obey any order but the one you propose?” Judge Reena Raggi asked.

“We would not voluntarily obey such an order,” replied Blackman — who later said Argentina would be no more likely to obey a US court than the US would be to obey an Iranian court.

If you get to choose whether or not to obey it, it's not so much of an order. It's good to be a sovereign. I mean, it's not great; as Felix Salmon says, "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."

But they can keep issuing domestic debt, and paying it in Buenos Aires, where Reena Raggi can't yell at them. This may come in handy for current holders of Argentina's New York law debt, who may soon run into trouble getting paid. Salmon maps out a likely endgame:

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. ...

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 ...

Whenever something "helps explain why credit default swaps are trading so much wider than bonds" you should be a little suspicious because CDS is a way to hedge bonds, so when they trade far apart it's a problem. And they are pretty far apart: Five-year CDS is trading at ~45 points up-front (~22% spread), while a 2018 9% bond is trading at a ~75 dollar price (~15.5% yield).1

We've had fun with various forms of sovereign-CDS brokenness in the past, and you could imagine one obvious sort of brokenness here. That brokenness would work as follows:

• Argentina doesn't pay bonds, causing a credit event.
• Argentina launches its exchange offer, and some people exchange into perfectly good Argentina-law bonds.
• But some people hold out a few New York law bonds and do not exchange them.
• The CDS settles, based on the price of New York law bonds, which - because they will never be paid - are worth roughly nothing.

So the CDS holders would get a windfall: if you have $100mm of bonds (bought today for ~$75mm) and $100mm of CDS (bought today for ~$45mm), for instance, you exchange $90mm of bonds (getting something worth ~75 cents on the dollar, or $68mm) and keep out $10mm (getting something worth ~0 cents on the dollar). Then your $100mm of CDS settles at 100 - 0, or 100, or $100mm. You spent $120mm and got back $168mm (plus some yield differential). Free money!3

This is a possibility I guess? The other possibility, which seems more likely to my untrained eye, is that the CDS auction will occur after a payment default but before the exchange goes through, so the price of New York law bonds will still reflect - as they currently do - the likelihood of their one day becoming more attractive Buenos Aires bonds.

In that case, CDS wouldn't really be broken here. Or rather, there's only the regular brokenness. Abstracting away from settlement auctions, CDS contracts provide that, if there's a default, you get $100 and have to deliver $100 par of bonds. But they don't specify which bonds; the category of "Deliverable Obligation" in the credit definitions is broad, and so for the most part you can deliver any bond you want. And so you deliver the cheapest. As one investor in Argentina bonds and CDS put it to me:

CDS was built on the [assumption] that upon default all deliverable bonds trade at the same price. The real-world justification for that assumption was that in a Bankruptcy, everybody accelerates their bonds and pretty much has a par claim that will be treated similarly. But for Restructurings and for Sovereigns, that assumption is obviously invalid. Hence, all the disputes you see relate to Restructurings and Sovereigns.2 Once the CTD [cheapest-to-deliver] option is so valuable, you get huge fights about what is or isn’t deliverable and what does or does not constitute an event – because an event creates huge potential windfalls relative to bond positions.

Argentina has, for instance, a JPY-denominated 0.45% bond due in 2038 (ISIN ARARGE03E659), trading (rarely) at a teens dollar price, or a USD 2.5% of 2038 (CUSIP 040114GK0) trading at ~$34/~11%. Buy a bond at $34, buy CDS at $45, watch Argentina default, and then make ~$21 on the package risk-free. Unless they don't default.4

Anyway. Some flavors of the bond/CDS disconnect here can be - or, at least, could have been - avoided by ISDA's plan to one day have a sensible treatment of "exchange property" (as equity people put it) in CDS contracts.5 Some of them can't be: in particular, the cheapest-to-deliver option is a key feature of CDS, making it more liquid and general-use than just a hedge to a specific bond issue. It's not a bug, it's a feature. Or I mean, it's somewhat bug-like, but it's a necessary bug.

One perception of ISDA, who make the rules on these things, is that it is dominated by dealer banks who err on the side of not paying out on CDS because dealers tend to write more CDS than they buy. (This may not be true!) Thus when the Greek default looked likely to hose CDS holders, there was much complaining by holders about how unfair that was and what meanies ISDA were. (It worked out fine in the end.) There's been much less complaining here, since it looks like CDS holders are more likely to get a windfall than a hosing on Argentina's rapidly approaching default. I wonder if that also means that the rules are more likely to change to reduce such windfalls in the future.

Why Argentina will default in 2013 [Reuters / Felix Salmon]
Argentina’s Bond Case Is Being Closely Watched for Ramifications [DealBook]
Argentina Says It Won’t Voluntarily Comply With Bond Ruling [Bloomberg]
Shove your order! [NYP]

1.Buy the package! Pay ~$120 up-front, get a $9 coupon, pay a $5 coupon on the CDS, and get back $100 in five years. At a zero discount rate that works out perfectly. Oh, unless there's a default.

2.There's a whole mishegas of maturity buckets in Sovereign Restructurings to partially address this, but they apply to restructurings, not payment defaults.

3.Ooh the other potential windfall is: has Elliott bought CDS on Argentina's new bonds? Everyone sort of thinks that, including one of the judges:

This could create a conflict of interest, the judge said. When asked if his clients had done such a trade, Mr. Olson said, “I have been informed it isn’t true.”

This seems harsh to me. Argentina have been pretty clear that they're not going to pay Elliott, and will default on the exchange bonds instead. So, like, why shouldn't Elliott be allowed to bet on a default on the exchange bonds? It may be the only way for it to get paid for its efforts. I'd certainly be buying CDS if I were them. Guess that would've made the court date kind of awkward though.

4.Other sequences are possible, with their own screwiness. For instance, Argentina could try to avoid a default altogether by forcing an exchange into local-law bonds before any payment is due, by launching an exchange offer with a collective action clause. The investor I quoted above explains:

This could get even screwier if Arg tries to use Collective Action Clauses to change the terms of the bonds to be local law, local payment. Most bondholders just want to get paid, so they might well constitute a majority for a CAC. Now, maybe this is not even possible because it violates the order. But if it is possible, and it gets done for some or all bonds, then these bonds might be rendered non-deliverable. If the CACs are used before a technical default, then you would wind up with a potentially small deliverables list. Oh, yes, and also a debate about whether change of law via CAC is a Restructuring Event under CDS.

5.Viz., "if a bond poofs into other stuff, the CDS deliverable is one bond's worth of the other stuff." This doesn't quite handle voluntary exchanges. One common approach in equity contracts is to say "if holders of the reference security are offered a choice, the reference security becomes whatever choice most of them take." There's a certain logic to that: if 90% of the NY law bondholders take local-law bonds, maybe the CDS should reference those bonds.

That said, I admire S&P's role as a stickler for the rules of a game that it invented and no one else is playing. Greece is conducting an essentially non-coercive exchange for its bonds at above their all-time high prices. Is that a "default"? Well, for what purposes? Legally, mostly no. For CDS, no. But for S&P, yes. (Yes, it is.) They're paying off their debt for less than par, so default it is. And since those are the rules, S&P must pointlessly note that Greece is in selective default.1

Nobody else seems to care much. What do you make of this?

It’s just two days before the books close on a plan to reduce Greece’s debt load by having the country purchase its deeply discounted bonds from banks and investors. But bankers close to the transaction are voicing concerns that hedge funds might “blow up the deal” by holding out for a higher price. ... [N]umerous hedge funds — many of which scooped up Greek bonds in the mid-teens this summer and are now sitting on fat profits — are telling Greece that they may not participate in the buyback. Instead, they are betting that the participation of Greek banks and short-term investors looking for a quick profit will be enough to get the deal done. In theory, the strategy would allow the hedge funds to cash out at prices of 40 cents and beyond when bonds rally in the aftermath.

What theory is that? Is it a theory expressed in price?2 In my simplistic mind, when people think that a tender is priced too low and they'll get a better deal after it expires, they should be buying bonds to profit when the price goes up. But Greek bonds are trading sort of in the middle of the range of prices that Greece is offering, which in a Dutch auction is perhaps most reasonably interpreted as meaning not that investors think the top end of the range is too low, but rather that the auction will in fact end up somewhere within the range. And they've come down a bit off their post-announcement-of-distressed-exchange euphoric high:

If you could buy the Greek 10-year today at 38.285, and sell it on Friday at 40.1, I guess you would, no?

Or maybe that's all wrong! Given various pockets of holdings, and the need to probability-weight any payoff, it's hard to reason from a market price. Maybe the bonds are down because the minority of people who are actually trading bonds think that there's enough supply locked away at mean holdout hedge funds to make the exchange fail; if the exchange fails, I'm guessing, nobody will be cashing out at prices of 40 cents and beyond.3 Or maybe they're just down because of the S&P downgrade.

Concerns Mount That Investors Might Balk at Debt Buyback in Greece [DealBook]
Greece Downgraded to 'Selective Default' by S&P [CNBC]
You’re in selective default (again), S&P tells Greece [FTAV]

1.So: was Greece in selective default on S&P's criteria on Monday? If not, why not? If so, why wait 'til today for the downgrade? Is there a complication I'm not aware of?

2.Relevant fact:

Also relevant fact:

3.Tangentially related: is it not a little odd that Oshkosh stock fell ~4% yesterday on news that ~70% of shareholders3a wanted Carl Icahn to go away and stop pestering them? If you think that the board's plan for shareholders is better than Icahn's cash tender, shouldn't sending him packing increase value? If you think it's worse, shouldn't you have tendered into his no-strings-attached offer? What does this tell you about shareholders' demand curves? What do Greek bondholders' demand curves look like? Etc.

3a.He got 22% in his tender and owned another 8%, so 70% didn't tender.

That's the entire history of the shortest-dated of bonds targeted for a buyback at, you might notice, their all-time high price.1 Various people have various reactions to this but one reaction that no one can have is of the variety of "well, I paid more than that to buy it, so I'm not selling it to you for less, since I live in a non-mark-to-market dreamworld." Nobody paid more to buy these bonds than Greece is planning to.2

At least, not in money. Some people paid for these bonds in suffering; others - most others - paid for them in the form of old Greek bonds, which once upon a time were, I guess, worth 100 cents on the dollar. Later, they weren't. Eventually they were rounded up in a restructuring where every €1,000 of old bonds got exchanged into €315 face amount of new bonds, €150 face amount of let's say par-ish EFSF notes, and €315 face amount of Greek GDP-linked securities which were worth around nothing. The total package was worth around €210-250, depending on what day you looked at it, which if you do the math assuming the EFSF bonds were worth par and the GDP warrants zero, gets you a value for those new bonds of €60-100, or 19 to 32 cents on the dollar of face amount.3

Now Greece is offering 30 to 40 cents on the dollar for those bonds. Hedge funds who bought them for less than that seem happy; Greek hold-to-maturity banks are grumbly about being forced into the offer, though for no discernibly good reason. Here you can fiddle with calculations of how much Greece will save by doing this buyback.

Here you can look at additional fiddling, which does various lazy simplifying things but makes the point that if instead of offering new Greek bonds way back in the olden days of March, the Greece/Troika entity had offered this deal, they could have retired about €40ish billion of debt, rather than the €29-31ish billion they're targeting today.4

Anyway, for your consideration. (Also consider: looking at that table, why would Greece buy in any of its shorter-dated bonds? It's paying both a higher dollar price and a higher yield for the bonds maturing in the 2020s; the higher dollar price means less "debt sustainability" bang for your buck, while the higher yields will look silly if Greece ever gets back to normal and its yield curve un-inverts. Are they trying to buy roughly equal amounts of each bond to appease the buy-and-hold investors who own the whole strip, or will they end up weighting this toward the back end?5)

Obviously the dynamics have changed: that graph at the top of this post pretty much stands for the proposition "when you go around saying you're going to buy up your debt, your debt gets more expensive." But as someone who is generally a big believer in can-kicking, I find the math, and the overall shape of that chart, somewhat sobering. Greece hit bottom, more-or-less defaulted on its debt, and now ... is coming back to ask for more. On worse terms, which makes sense: with Greece looking less desperate and more Troika-supported, why should you sell it back its bonds at a steep discount?

I guess you can look at it from the investor's perspective: if you took the original Greek exchange, you thought you were getting 23 cents on the dollar for your old bonds (and your CDS paid out ~78.5 cents); if you held from now until then it turns out you're getting more like 25-26 cents of value. (Plus maybe those GDP warrants will pay off?) Which I guess is a good thing: it's always easier to get investors to take the next deal if they made out well on the last one. Perhaps this sell-low-buy-high strategy is smart in the long run.

Some fiddling re: Greek bond buyback [Google Docs]
Greek bond buyback [Reuters]
Greece Offers to Buy Back Debt [WSJ]
Invitation / Press Release [Hellenic Republic Ministry of Finance, via FTAV]

1.Other series are similar; here is the longest-dated:

You might recognize this bond as the one used to settle Greek CDS auctions in March; it cleared at 21.5 then. Greece is now offering 30.2-32.2.

2.Excepting, trivially, anyone who's buying them within (above?) the offer price range today (or tomorrow, etc.). This seems to be happening.

3."Cents on the euro!" you shout, but I ignore you, because the units cancel, it's just a percentage. "Centimes on the franc," I could have said. Or like a Game of Thrones currency, if it's decimal. (Is it?) 48 to 80 pence in a pre-decimalised guinea, I could have said.

4.That math is in the blue box at the bottom, scroll down. Re: lazy assumptions, etc.: One is that "YTM" is a directional stab at a curve, not an actual answer. Another is that I don't really do anything but make unfounded assumptions about the EFSF bonds and GDP warrants. Also for March 9 trading values I just use Bloomberg's HP number for that day (with one exception that looked funky so I used the next day); not clear how real that is.

5.I guess that could have been a footnote.

The particular things that are or might be happening are, officially:

• Greece is getting €43.7bn in new loans from the European Financial Stability Fund,
• Its old, direct loans from other EU countries will have a 100bps lower interest rate than they used to, and its old and new EFSF loans will have a 10bps lower "guarantee fee cost."
• The old and new bilateral and EFSF loans will have be extended by 15 years, and the EFSF loans' interest will be deferred for 10 years.
• The other EU countries will give Greece the profits from Greek bonds they bought at a discount in previous support programs.
• Greece will try to buy back some public bonds in the open market at prices "no higher than those at the close on Friday, 23 November 2012," which means about 35 cents on the dollar (16.3% yield) for the ten-year.

This structure - except for the last part, which is just fun2 - is designed to accomplish the two perennial goals of:

• reducing Greece's debt, and
• saying you haven't reduced Greece's debt because it's, like, "illegal" or something to reduce principal of official loans.

I have made my own proposal for reducing the principal that Greece owes while not reducing the principal that its lenders are owed, because that is a thing you can do if you have levers like massively reducing the value of a debt through interest cuts and maturity extensions, but it seems to have been ignored. Maybe next EU conference! That's in, what, three months?

Felix Salmon discusses this magic of reducing the value of the loans by extending them past the halfway mark of our young century out of desire to avoid principal reduction, then adds "I don’t know if anybody’s done the math to work out what the effective NPV haircut is here." So: it's tempting to do so, because (1) I live to serve etc. and (2) a thing I actually like to do is pretend that things that happen in the official sector happen in the real world, and apply NPV math to them, and be all, what's up, NPV math. This is not, it seems, a very productive endeavor, but here we are.

It's particularly unproductive for Greece because of the confusion and obfuscation involved, but here is a stab in the dark; take this as less "here is what happened" and more "here is a template for doing really rough math if you had better data and were so inclined." But with that and many other caveats,

• if you take the €170bn of official-sector loans (but not including SMP bonds, IMF loans, or a few miscellaneous things) that I can readily get traction on,
• prior to yesterday, they were worth in a super-rough ballparky way €66bn-ish,
• and now they're worth €36bn-ish, for a haircut of €30bn, 18% of par, or 46% of what they were worth yesterday.
• Assumptions, errors, etc.!3

These are all fake numbers both because the data is patchy and because they're sort of not the point; the point is to return Greece to a sustainable path where it pays off all its debts, its borrowing costs come down, and when we all look back on this in 2057 we'll laugh about how pessimistic our discount rate assumptions were. Of course this is true in any restructuring: you don't understand, the borrower says, you'll actually get paid more this way, because we can actually pay you this reduced/extended amount, whereas the other way, man, good luck.

I suppose giving Greece ten years before they have to pay back any money, and forty-five years before they have to pay back all of it, is a helpful way to get to that point. Whether it is more helpful than keeping the schedule the same and just lopping €30bn off the principal amount of their debt is beyond my pay grade. There's no particular reason to think that those two approaches are equally helpful for Greece: you might care more about cash flow, or more about sheer amount of debt, and that would influence which approach you'd take. I'm just here to do the fake-o arithmetic, and the fake-o financial engineering, to show that on a certain narrow view of the world they're the same thing.

Eurogroup statement on Greece [EU]
Euro zone, IMF reach deal on long-term Greek debt [Reuters]
How the official sector restructures, Greece edition [Reuters / Felix Salmon]
A ‘broader concept of debt sustainability’ for Greece (feat. OSI-lite) [FTAV]
A thing that is almost like Greek debt math [Google Docs]

1. That's a year. You probably knew that? I dunno, it looked strange to me. 2057. I feel like I'm writing science fiction. Boring, boring science fiction.

2. Would you believe that that bond closed just over 35 today? You would? Would you expect it to close much below there between now and the end of Greece's buying efforts?

3. Oh gosh those. Really, better ideas or data would be welcome. So there are two main sources of funds, let's talk about them separately.

First there are EFSF loans, of which here is a sample document, which are at EFSF's cost of funds plus (i) some margin, which for Greece has been zero for a while, plus (ii) a "guarantee commission fee," which was lowered from 10bps to zero yesterday. Here is a table with amounts disbursed, maturities, etc. on those loans. Another €43.7bn was unlocked in the current deal but the terms of that are opaque to me; I am assuming a 2027 bullet maturity (pushed out to 2042) for no reason other than that that's what the last couple of tranches were.

Then there are the bilateral loans - the Greek Loan Facility - and related IMF loans. These are sort of described here but not in a way containing any information. The bilateral loans are at floating rates, basically Euribor plus some margin; that margin was 150bps and was reduced by 100bps so, I guess, it's 50bps. Their interest payments were not deferred, unlike the EFSF interest payments, though their maturity was pushed back.

For basic assumptions, because I don't know (1) future Euribors or (2) the EFSF's cost of funds, I've just used (1) Euribor swaps for the bilateral loans and (2) EFSF extant bonds for the EFSF loans, roughly matching maturities. For a discount rate, I've used 16.25% based on 10-year Greek bonds, for basically no reason.

For what changed, I assume that there was a 10bps reduction in commitment fees on the EFSF loans, a 100bps reduction in interest on the bilateral loans, a 15 year maturity extension on all of them, and a 10-year deferral of interest (followed by immediate lump-sum payment of deferred interest??) on the EFSF loans. I also assumed that the floating and floating-ish rates would be 12bps higher, which is just eyeballed from the difference between 30, 40 and 50-year eurozone swaps (Bloomberg IRSB, Euro Zone). Just for fun I also lowered the discount rate for the new world order to 13%, based on the Greek 30-year bond, which seems like a super-rough way to give credit for the theory that this will make Greek debt more sustainable etc.

Here is a note from JPMorgan's Vladimir Werning on what might happen next; my favorite outcome is this:

- Argentina deposits GDP [i.e., GDP warrants, the first thing that gets paid, but the same logic applies to actual bonds - ed.] by sending check to Cede,
- Argentina does not deposit money for holdouts in escrow
- Cede has property of funds on behalf of bond holders
- Cede does not transfer to DTC but its possession means Argentina has extinguished its obligation de Jure
- The funds for GDP sits idle in Cede - they cannot be attached by Court, but cannot be taken out by bond holders
- Holdouts claim Argentina has re-routed the payments and is not complying with injunction
- Argentina's lawyers claim payment to Cede is contemplated in the indenture and does not constitute re-routing
In Cede option there is no dispute, obligations have been extinguished de jure, no default, technical or otherwise.

Cede, of course, being the DTC nominee that is the registered holders of all of Argentina's bonds;1 Werning points out that, while the normal method of paying bondholders is by sending a check to BoNY to send to Cede, sending a check straight to Cede also fits the requirements of the indenture. And because Cede is the only holder of the bonds, if Argentina pays it, then it's paid the bonds, and there's no default, technical or otherwise, no triggering of CDS, and nothing bad has happened. Argentina-wise and bond-wise. Actual bond investors might disagree.

I assume there's something wrong with this because it's too easy, but it's not easy to see what is wrong. The document really does allow Argentina to send a check directly to the holder of the bond, viz., Cede.2 Cede really can't transfer the funds to DTC - the judge's order and opinion prohibit DTC from abetting "any violation of this ORDER, … such as any effort to make payments under the terms of the Exchange Bonds without also concurrently or in advance making a Ratable Payment to NML," but don't seem to contemplate actually taking money out of Cede's pockets if it somehow ends up there. (Cede is after all a good-faith transferee, though it might get in trouble as a transferor.) And there's no default because the only holder of the bonds - Cede - has been paid in full according to the terms of the bonds.

Of course the beneficial owners of the bonds might like this less, but their complaint is with DTC, not Argentina. Presumably their paying arrangements with DTC include provisions like "DTC will actually pay you the money due to you," but, again, that's an issue for DTC, who would be in the situation that BoNY was complaining about last week: on the one hand, they are legally obligated to pay out the money; on the other hand, doing so would be contempt of court.

Felix Salmon says "Elliot vs Argentina is a domestic Argentine issue" and I suppose it is, among other things. But those other things, man, are they things! The case is also a clusterfuck for the future of sovereign debt restructuring, and also sovereign debt generally, and also New York's status as a global center for sovereign debt and maybe private debt and oh everything.

But Argentina could make a lot of those things go away and turn them into a clusterfuck for DTC. Which, y'know, they're the biggest thing ever, so that's not trivial. If the thing that holds all securities for all Americans, and whose smooth functioning allows American securities markets to work, just stops paying people the money it owes them, that is ... troubling for the American financial system. But not so much for Argentina. You could imagine Argentina just paying off the one holder of its exchange bonds and walking away whistling while that one holder nervously explains to all of its participants why they can't have their money.3 And then maybe adding "hey next time buy our local-law bonds; at least our financial system works."

Part of me wants this to just be pure harmless abstraction. After all, having securities at DTC is exactly as good as having them in your personal vault - better, really - so why shouldn't having money at DTC be just as good as having money in your actual hands? (Isn't it kind of? Netting, etc.) But realistically money is money and a claim on money at DTC is not to actual money what a claim on securities at DTC is to "actual securities," whatever those are. So yeah, if you were a bondholder, you'd be pissed.

Also if you're just a person invested in the effective functioning of the U.S. financial system. Here's Anna Gelpern:

The heretofore half-hearted policy interventions on Argentina's behalf signal that the establishment is not all in. It would be interesting to see whether Judge Griesa's expansive opinion gets anyone off the fence, and whether muscular policy intervention now would be too little and too late.

The U.S. establishment can be half-hearted when its interventions are on behalf of Argentina, which whatever else you can say about it is after all a defaulted sovereign debtor. But Argentina isn't really on the hook here: it can just proceed normally, following the terms of its contracts (the new ones I mean) and making all of this DTC's problem. And when the problem is at the core of the US financial system, you can imagine a different outcome.

Pari Passu Wipeout in the Southern District [Credit Slips]
Why we might soon see another Argentine default [Reuters / Felix Salmon]
Argentina default looms [IFR]
Argentina: Set to appeal until it becomes necessary to offer investors (the now NPV positive!) off-shore payment option [JPMorgan]
Argentine Sovereign Debt [Shearman & Sterling]

1.Oh fine boring there's also a depository for some bonds for non-US clearing; the depository is Bank of New York Mellon, not to be confused with the bit of BoNY Mellon that is the paying agent. I'll ignore this for simplicity and rhetorical effect; you can do the same with BoNY depository as you do with Cede.

2.See page C-2 here, the form of note:

The Republic will make payments of principal of and interest on the Securities by providing the Trustee or trustee paying agent the amount of such payment, in [U.S. dollars] [euro] [Other Currency] in immediately available funds, not later than 1:00 P.M. local time on the Business Day prior to the Payment Date, and directing the Trustee to hold these funds in trust for the Trustee and the beneficial owners of the Securities in accordance with their respective interests and to make a wire transfer of such amount in [U.S. dollars] [euro] [Other Currency] to the [ ] as the registered owner of the Securities, which will receive the funds in trust for distribution to the beneficial owners of the Securities; provided that the Republic may, subject to applicable laws and regulations, make payments of principal of and interest on the Securities by mailing, or directing the Trustee to mail, from funds made available by the Republic for such purpose, a check to the person entitled thereto, on or before the due date for the payment at the address that appears on the security register maintained by the Registrar on the applicable record date.

3.IMPORTANT BONUS: no technical default means not only no awkwardness around "we've defaulted on our bonds," but also no triggering of CDS. (Probably?) Everyone thinks that Elliott is hedging3a with CDS so it would make money if Argentina defaults on its bonds, and lose if Argentina enters non-default limbo. If you hate Elliott - and if you're Argentina why wouldn't you? - that's a nice win too.

However, important non-bonus: if you're in the business of actually borrowing in international bond markets, you want your actual investors to actually be paid; telling them "well you got paid in theory" doesn't quite suffice. Thus Werning points to the likelihood of some sort of exchange or local-payment workaround where holders get the choice of (1) being paid into DTC according to the bonds' terms, uselessly, or (2) being paid in Buenos Aires, outside of the terms of the bonds, but with actual money.

3a.Oh yes: hedging. Elliott has won, so Argentina owes it $1.3bn. But Argentina doesn't have to pay them that as long as it pays zero dollars on its exchange bonds. So the rough outcomes are (1) Argentina pays Elliott $1.3bn and pays off exchange bonds or (2) Argentina pays Elliott $0 and defaults on exchange bonds. Buying CDS smoothes outcomes between those two states of the world. Unless there's a third state.

• Argentina had some Old Bonds, decided not to pay them (in 2005, more or less), got most of their holders to exchange into New Bonds at pennies on the dollar, started paying the New Bonds, stopped paying the Old Bonds, the usual.
• Elliott Associates bought up lots of Old Bonds at pennies on the dollar, didn't exchange, travelled the earth suing and capturing warships and stuff.
• Elliott won a big lawsuit against Argentina, getting a US district court and the Second Circuit to declare that Argentina couldn't make any interest payments on the New Bonds without ratably paying off the Old Bonds.
• Argentina doesn't want to pay off the Old Bonds.
• But it does want to keep paying the New Bonds.
• The district court now has to, among other things, clarify its injunction saying that Argentina can't pay New Bonds without paying Old Bonds.
• Specifically: how, if at all, will that injunction apply to various people in the "payment snake" - indenture trustee, securities depository, banks and brokers and whatnots - that snakes between Argentina, which has the money, and the New Bondholders, who want it?
• Simplistically: Elliott thinks that anyone in the snake who takes money from Argentina and passes it on toward New Bondholders is "aiding and abetting" Argentina in violating the injunction. The snake members are more of the opinion that they're just a snake and can't be held responsible for what passes through them.

The head of the snake is Bank of New York Mellon, the indenture trustee on the New Bonds, who are in the unfortunate position of getting money from Argentina and dishing it out to New Bondholders. If the injunction applies to BoNY, then they will be in contempt of court if they do their job. They don't like this, and filed a brief last Friday saying why.1 They are not alone in this; various other bits of the snake and their caretakers - the New York Fed, DTC, the Clearing House Association, etc. - have expressed similar emotions.

But BoNY is perhaps most affected and no one wants to go to jail just for being an indenture trustee, so they are full of good arguments about how they are not working for Argentina, have no duties to it, really only met Argentina that one time, and all in all are just agents for the New Bondholders and so can't possibly be "aiding and abetting" Argentina or bound by the injunction. I find this pretty compelling actually!2 On the other hand, not binding anyone but Argentina to the injunction means in practice that Argentina can keep paying the New Bondholders while screwing the Old ones, since a US court can't really enjoin Argentina all that effectively.3 This is not that appealing, so there's some practical reason for the court to tell BoNY "tough luck, you're an extension of Argentina, and so you have to do what we told Argentina to do."

BoNY is well aware of that, because at some point its brief turns from a sympathetic and full-throated defense of its obligations to bondholders to … sort of the opposite. The shift starts innocently and metaphorically enough:

If the Court nevertheless concludes that BNY Mellon is bound by the Injunction and Argentina subsequently fails to make a Ratable Payment, BNY Mellon will face a potential conflict between its obligations to the Exchange Holders under the Indenture and its obligations to the Court. In that instance, BNY Mellon needs judicial guidance as to its duties and responsibilities. BNY Mellon should not be forced by Argentina’s independent violation of the Injunction to choose between exposing itself to the risk of contempt, on the one hand, or the risk of claims from Exchange Holders for breach of the Indenture, on the other. A path to avoid this conflict is charted by the Indenture, but BNY Mellon fears it cannot traverse it safely without judicial imprimatur.

But then it moves on to cite all the "wide range of exculpatory provisions" in the indenture, "which are designed to protect BNY Mellon from being exposed to liability." This is true. The list includes:

• "BNY Mellon cannot be liable for any actions taken in good faith absent gross negligence";
• "BNY Mellon is not required to expend, advance, or risk its own funds or otherwise incur personal financial liability in the performance of its duties"; and
• BNY Mellon doesn't have to do anything "illegal or contrary to applicable law or regulation."

So BoNY asks that, if the court won't let it go about its business of paying New Bondholders, it at least make it clear that BoNY is off the hook:

Consistent with the foregoing, to the extent that the Court extends the Injunction to BNY Mellon, it should make clear that BNY Mellon is under no obligation under the Indenture or otherwise to expose itself to contempt sanctions by paying out any funds delivered by Argentina in the event that Argentina violates the Injunction.

BoNY lasted 15 pages before throwing the New Bondholders - y'know, the people it's supposed to be working for - under the bus. Under the ceremonial sail-powered warship is I guess the right metaphor here.

Anyway who can blame them? What's fun is to imagine what happens if BoNY loses and Argentina just keeps on paying the New Bonds as it used to, which I guess is the default expectation. What happens?

Meh, who knows. Elliott in its brief and reply brief on remand argue that the court should enjoin Argentina to pay ratably - so if it pays X% of the interest and principal due to the New Bondholders in December (when the next payment is due), it has to pay X% of the principal and interest due on the Old (defaulted, accelerated, due in full) Bonds. Some rough math: Argentina has about $3 billion of scheduled New Bond payments due in December, and about $8 billion of defaulted Old Bonds. So if there's $3 billion to be paid, it should by that formula go ~27% (~$800mm) to New Bonds and ~73% (~$2.2bn) to Old Bonds. That much is specific enough but Elliott gets a bit vague on the logical next step, which is that the court should just instruct BoNY to pay out 27% (or whatever) of any money it gets from Argentina to the New Bondholders, and give the rest to the court to hand to Elliott and friends. But I guess that is the answer? Thoughts?

Also open for thoughts: Of course we can't come this far without taking a quick peek at Section 4.5 of the Credit Derivatives Definitions:

"Failure to Pay" means, after the expiration of any applicable Grace Period (after the satisfaction of any conditions precedent to the commencement of such Grace Period), the failure by a Reference Entity to make, when and where due, any payments in an aggregate amount of not less than the Payment Requirement under one or more Obligations, in accordance with the terms of such Obligations at the time of such failure.

Any views on what happens if Argentina pays BoNY and BoNY, under the watchful eye of the U.S. District Court for the Southern District of New York, hands out three-quarters of the money to Elliott and a quarter to the bondholders? If BoNY is not part of the "Reference Entity" (Argentina) but just an agent of the New Bondholders, then BoNY getting the money and then handing it over to Elliott really shouldn't trigger CDS, should it? Argentina, after all, has not "failed to pay." The payment just got eaten by a snake. Though there's this:5

There is some question about whether there is a "failure to pay" if Argentina transfers funds to BoNY in Buenos Aires, but BoNY fails to pay the bondholders in New York. There is just barely enough fog in the indenture to give ISDA and its lawyers some room for interpretation (though the "received by Holders" language in the indenture cousels caution). The rumor mill has it that Elliott holds lots of CDS on Argentina; it is on the Determinations Committee charged with deciding whether there would be a credit event.

OH BOY am I looking forward to a contentious fight over whether Argentinian CDS is triggered next month. Others seem not to be. Here is Bloomberg today:4

Traders are reducing bets Argentina will default within a year on speculation that enforcement of a U.S. judge’s order to seize some bond payments will be delayed by a Bank of New York Mellon Corp. legal plea in the case. … The cost of credit-default swaps that insure against a default over the next year dropped for the first time in eight sessions on Nov. 19 and closed at 6,098 basis points yesterday, down from a record 7,455 on Nov. 16.

I guess? 61 points seems like a lot of confidence that the convolutions here will end up triggering CDS. But then, Elliott's done pretty well so far.

N.Y. Fed Backs Argentina in Case Involving Debt-Service Payments [DJ]
Argentine Sovereign Debt [Shearman & Sterling]
Joseph Cotterill on Argentina [FTAV]
Pari Passu Endgames [Credit Slips / Anna Gelpern]

1.That comes from this repository of all things Argentina at Shearman & Sterling, as does most of the next sentence.

2.Important: BUT WHAT DO I KNOW? I reason by analogy though: the court presumably wouldn't apply the injunction to the New Bondholders; i.e. if Argentina succeeded in getting their money to them the court wouldn't take it from them to give to the Old Bond holders. (I know this in part because Argentina has gotten them their money in the past, before this judgment, and nobody's trying to take it away from them.) So the question: when does the money pass from "Argentina and its extensions" to "bondholders and their extensions"? If it's in Argentina's treasury, or in the hands of their agents, then it's Argentina's and you can take it. If it's in the hands of the New Bondholders, or their agents (like, in their bank account, for instance), then you can't. If the indenture trustee is an agent of the New Bondholders, then you can't take it from the indenture trustee. That's a conceptually debatable question - the bondholders didn't like find and hire BoNY; Argentina did - but BoNY cites various legal-looking stuff to say that it's the bondholders' agent, not Argentina's. But, again: what do I know?

3.Since it's all the way over there in Argentina. Plus it has a navy, albeit a slightly reduced one.

4.Terminal-only so far I think?

5.There are others who seem more sanguine - Shearman & Sterling, for instance, think partial payment would clearly be a credit event, though they don't break down partial payment by Argentina vs. partial pass-through by BoNY. Also here is a take from JPMorgan about various re-routing-of-coupon options that might or might not trigger CDS.