Saturday, February 12, 2005

Argentina deals with time inconsistency

Here is another wrench in the works of the Argentine debt restructuring negotiations. It shows how collective action isn't really as efficient as people sometimes think, because it is easier for some parties to make certain kinds of commitments, or to get organized and lobby in favor of their interests, than for others.

Right now, the Argentine government is trying to get its creditors to accept a skimpy offer to restructure its current defaulted bonds. The government is offering roughly 30 cents on the dollar, and a group of bondholders are trying to organize creditors in order to reject the offer. The creditors make a very good argument that Argentina can pay more.

The problem is one of externalities. Individual bondholders have an incentive to accept the offer that Argentina has made if they expect that this is the best that they can get, at least for a long time. As a group, however, bondholders would probably be best off if they could present a credible threat that they will not accept the current offer. In order to do so, they could use a good commitment mechanism. Something that could give credibility to the threat that they will not accept the government's offer.

The government, on the other hand, has a problem of time inconsistency. It has an incentive to promise that the current offer is the best it will ever do, and that those bondholders that do not accept the offer will simply be stuck with worthless pieces of paper forever. Later on, however, after the offer has been made, the government will have an incentive to renegotiate with those recalcitrant bondholders that did not accept the offer in the first place.

And thus we have the negotiation playing field. Bondholders want to show that they will not accept the offer as a group, but individually they have an incentive to accept. The government wants to credibly promise that this is the final offer, but ex-post has an incentive to improve the offer. Whoever can be more credible in its weak promises will win.

Well, it turns out that the government has found a commitment mechanism to help it. It has submitted a law before congress (and congress has approved it) that will make it illegal to negotiate with holdouts, and that will delist all of the debt that is not tendered into the negotiation.

Thus, the government has a very good shot at winning this game, because its effectiveness at beating the time inconsistency problem is better than the bondholders' ability to deal with the limits of collective action.

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