The Economist - USA (2020-08-29)

The EconomistAugust 29th 2020 Finance & economics 61

2

Buttonwood Pinky v Blinky

A

lthough oldenough to feel nostal-

gic about classic video games, But-

tonwood was never a fan of Pac-Man. Yes,

eating pellets and eluding colourful

ghosts made a change from shooting

waves of space invaders. But the game

never grabbed him. And its name made

no sense. The original, "Puck Man", was

apparently altered to stop arcade vandals

changing the pto an f.

Emerging-market investors may

share those cool feelings. To them, “Pac-

Man” is the name for a divide-and-rule

strategy pursued by governments seek-

ing to puck their bondholders. Fear of the

tactic haunted Argentina’s $65bn-debt

talks, which have eventually come to a

deal that most bondholders looked likely

to accept by August 28th, after The Econo-

mistwent to press.

A government that cannot pay its

debts typically offers to swap its bonds

for new ones with gentler terms. Under

modern “collective-action” clauses, it

can group together any bond series it

wants to exchange and take a vote of all

their holders. If a large majority agree to

the swap, it becomes binding for all. This

stops a few mercenary creditors free-

riding on the generosity of others by

holding out for a better deal, hoping that

the government will pay them more once

it has paid everyone else less.

The absence of such provisions al-

lowed a colourful group of hold-outs to

chase Argentina for almost 15 years after

its default in 2001. At one point, nml

Capital, a hedge fund, managed to pre-

vent Argentina paying any creditors until

it paid them all, a legal feat that upset

other bondholders almost as much as it

upset the government.

Creditors do not always see eye to eye.

A stingy minority may antagonise every-

body else. Similarly, a pliable minority

who are desperate for a deal may not share

the interests of the harder-headed major-

ity. The Pac-Man strategy exploits this

difference. Consider the following case,

based on a blog post by Mitu Gulati of Duke

University and Mark Weidemaier of the

University of North Carolina at Chapel

Hill. Suppose the government needs two-

thirds of investors (weighted by principal)

to agree to swap 200 bonds. The bonds are

equally split into two varieties, pink and

red. About 67% of pink bondholders sup-

port a swap. But only 33% of red ones do. If

all vote together, the swap fails (only 100,

or half, vote in favour).

Suppose instead the government first

makes an offer to pink investors. This

separate offer will succeed and become

binding on all pink bondholders, includ-

ing the 33% who voted against. Next, the

government makes a second, slightly

sweeter offer to both red and pink. All pink

holders will support the second offer,

because it is a little better than the earlier

deal to which they are all now bound. With

100% of pink votes in its pocket, the gov-

ernment needs only a third of the red votes

to get a two-thirds majority of the two

groups combined. The swap succeeds. A

government that could not gobble up two

ghosts at once can devour both—after

first chewing and regurgitating one.

In practice, the Pac-Man strategy is

not easy. Votes are hard to predict. And

Argentina had to clear a second thresh-

old to swap its newer bonds. As well as

winning a two-thirds majority overall, it

had to win a 50% share of each legally

distinct bond included in the swap. If the

50% bar was not met for even one bond

series, the entire swap would fail.

To overcome this problem, Argentina

proposed "redesignation". It would make

an offer, count the votes, and then, if

necessary, declare some bonds ineligible

for the swap after all, allowing it to dis-

regard their votes.

Creditors immediately cried foul,

arguing that redesignation was under-

hand and unfair. But although Argenti-

na’s proposal breached the spirit of its

contracts, it did not violate the letter. It

merely interpreted the terms to its best

advantage—something its more trouble-

some bondholders, such as nmlCapital,

have previously done with brio. The

government’s proposal this year was

“aggressive, creative, and right there in

the documentation”, says Anna Gelpern

of Georgetown University. Instead of

complaining, creditors should have said,

“Oh crap, you read the contract better

than I did.”

In the end, redesignation was not

necessary. Argentina sweetened its offer

enough to win over the creditors (and

agreed to make redesignation harder in

the future). By seeking compromise, the

government proved something Pac-Man

fans have always known: you can some-

times stop a ghost from chasing you for a

bit by taking a step in its direction.

For fixed-income investors, hell is other bondholders, as Argentina shows

tween 60% and 80% of the purchase price

to live rent-free for two years. The deposits

have helped landlords finance further

property purchases. But they make it hard

for anyone without the savings to find any-

where affordable to live, even if they rent.

Seoul may seem cheaper than cities such as

London or Hong Kong when prices are

compared to incomes. But it is less afford-

able than it looks.

There are other strains. Household debt

is high, having risen rapidly in the past.

“The economy as a whole is far too exposed

to the property market,” reckons Hahm

Joon-ho, a former member of the Bank of

Korea’s monetary-policy board now at Yon-

sei University in Seoul. “If prices fell sud-

denly, it would be very bad.”

In the short term, then, the govern-

ment’s inability to bring down prices may

be no bad thing. No one wants to see a sud-

den house-price crash at a time when the

economy is already suffering a pandemic-

induced slowdown. The economic fallout

from the virus could curtail household in-

comes. That might delay the economic re-

covery as people cut back on their spending

in order to service their loans, although in-

terest-rate cuts should provide some relief.

In the longer term, though, the problem

of affordability will have to be dealt with.

Increasing supply is likely to be a much

more promising way of bringing house

prices down than intricate policy interven-

tions, says Mr Hahm. There is no sign that

Seoul will become less attractive as a place

to live, or that prospective homeowners

will become less exacting in their tastes.

“More and more people want to live in

high-quality apartments. Seoul does not

have enough of those—and so we need to

build more.” 7