After two days of intense talks leading up to the extended deadline of July 30th, Argentina was declared in default, its second in 13 years. Although various plans were proposed to avoid this result, such as coupon repayment and Argentine banks buying up the debt, Elliott Management refused any and all proposals to restructure, acting against the other 92% of creditors that accepted reduced repayments in 2005 and 2010.1 If Elliott Management would accept an offer, it would make over 150 times its initial investment. Dissatisfied, the holdouts want a full repayment plus interest, amounting to over 1,200 times their initial investment.2 This “vulture” behavior is characteristic of Paul Singer, Elliott Management’s founder and CEO. His hedge fund seeks out a country in distress, buys its debt and demands full payment, typically without concern for possible detrimental economic effects and threatening poverty levels.3 For Argentina to pay Singer’s hedge fund in full it would cost every Argentine more than $3,500, just over one third of the country’s per capita income. At a maximum Argentina could payback the holdouts at the rate of 30 cents to the dollar, which is exactly what was accepted by the restructured bondholders throughout the past decade.4
Fortunately for Argentina, the economy is more stable with this default and there are other options for international credit with trade partners China and Russia. However, there will certainly be new difficulties accessing certain credit markets with particular links to Wall Street. Argentina’s stock market has not yet collapsed, which is a good sign overall, but there are various economic “pressure points” that worry Wharton finance professor Franklin Allen. The economy is growing very slow, almost negatively, reserves are falling and inflation is high. There is a moderate possibility of another devaluation and pressure on wages could cause inflation to soar even higher. Argentina’s bonds have been downgraded to the default grade and the cost of insurance on them has risen accordingly.9 In addition to the lingering domestic economic problems at hand, several international issues are of concern to the financial world.
What will be the effect of Argentina’s default on global finance and sovereign lending? Many believe the default is not a global concern. JPMorgan recently calculated Argentina’s emerging markets bond index at 2%, meaning the chances are very low that the default will have any serious knock-on effects on other South American economies.5 Wharton’s researchers share this opinion, but warn that a devaluation could cause some domino effects within MERCOSUR. Franklin Allen of Wharton has explained the true importance behind the default is that it “sets a precedent.” Sovereign default on bonds will be a more problematic issue for every country that is borrowing. It is predicted that some countries may switch to other kinds of debt to avoid déjà vu of the Argentine situation.9
Why is there no bankruptcy court for sovereign nations? Anna Gelpern, professor of law at Georgetown and senior fellow at the Peterson Institute of International Economics, compares the private and public processes of declaring bankruptcy and defaulting on debt; “When a government runs out of money there is no such process, all you have are a bunch of contracts and it’s every person and fund for themselves.”6 Historically there have been backup plans for default built into contracts between private hedge funds and public bond issuers, but most lenders don’t want to discuss potential defaults when bonds are being issued. Gelpern points out more pre-determined plans of action for default could potentially eliminate huge international financial disputes like this one. Also, technically, countries cannot go “bankrupt” like a corporation can; sovereign property cannot be seized as private property can.7
This case, under the decision of Judge Thomas Griesa of New York has alarmed many in the overwhelming trust in the US judiciary. Previously in June, Argentina attempted to pay a $539 million interest payment to its restructured bondholders. Greisa deemed this payment illegal and froze the money due to the equality clause in the lending contract. Called Rights Upon Future Offers, Argentina cannot make payments to the restructured bondholders without also compensating the holdouts. Violating this clause could cost Argentina up to $120 billion in fines.4 Thus, in this case there is so much power held by a single creditor that no other creditors can be paid.7 Since the deadline passed, Argentina has declared that it is not in default because of this attempted payment, a claim Judge Griesa has repeatedly condemned and threatened to hold the country in contempt.8 The US cannot coerce Argentina, but it can penalize those who do business with Argentina, increasing creditor risk even more than their economy already induces.6
Most recently Argentina has called to Washington to intervene, claiming the country’s sovereign immunity. The executive branch has not expressed any intent on stepping into the case and has repeatedly urged continued mediation between Buenos Aires and its creditors.8 Argentina has publicized its openness to third party solutions along with reminders to the international community that this vulture-like behavior hurts the poorest people in the world that could be benefitting from funds that could be building infrastructure, new schools and providing debt relief.2 Daniel Pollack, the court appointed mediator, has also acknowledged these real world effects. He stated his concern that this default is painful in that it hurts real citizens and acknowledges that Argentina has tried to payback the creditors that were willing to negotiate.3 The overpowering reliance on the US judiciary has placed this issue in a unique limbo that has many questioning the court’s jurisdiction and wondering about a weakened the rule of law.
What is going to happen? Possibilities are many with regard to how Argentina should act. Some say Argentina should attempt to renegotiate with the restructured bondholders, and attempt to work around RUFO, while continuing to refuse payment to the holdouts.2 Argentina could also do nothing and wait until the clause expires on the last day of 2014 to begin again with interest payments to the 92%.8 In its current state, some are concerned about Argentina finding any investment any time soon. Mauro Guillen, Director of Wharton’s Lauder Institute points to Argentina’s history of sovereign defaults, the most of any country, one every 10 years or so. He correlates it to the relatively powerful, typically populist spending, executive branch that has few checks and balances. Guillen expresses his lack of concern for Argentina’s near financial future simply because a default such as this, followed by a recovery of economic growth is not unusual; “Until [Argentina] changes in a major way, it will continue to be a very risky place to invest. What are the prospects of that happening soon? They haven’t changed in 60 years, so I don’t know how likely that is.”
Sources:
1) Mathew, Jerin. “S&P declares Argentina in Default as final talks fail.” IB Times. Available at:http://www.ibtimes.co.uk/sp-declares-argentina-default-final-talks-fail-1459083
2) “Don’t cry for d(efault) Argentina.” World Finance. Available at:http://www.worldfinance.com/inward-investment/dont-cry-for-default-argentina
3) Abelson, Max and Katia Porzecanski. “Paul Singer will make Argentina Pay.” Bloomsberg. Available at: http://www.bloomberg.com/news/2014-08-07/banks-said-to-be-arranging-argentine-debt-buyer-group.html
4) Schatzker, Erik, Katia Porzecanski and Dakin Campbell. “Banks said to be arranging Argentine debt buyer group.” Bloomberg. Available at: http://www.bloomberg.com/news/2014-08-07/banks-said-to-be-arranging-arge...
5) Ammachchi, Narayan. “Argentina defaults on debt and inches closer to economic crisis.” Nearshore Americas. Available at: http://www.nearshoreamericas.com/argentina-defaults-inches-closer-crisis/
6) Ben-Achour, Sabri. “Vultures show Argentina no mercy.” Marketplace.org. Available at:http://www.marketplace.org/topics/world/vultures-show-argentina-no-mercy?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+APM_Marketplace+(APM%3A+Marketplace
7) Rosenheck, Dan. “Argentina’s rational default.” The New Yorker. Available at:http://www.newyorker.com/business/currency/argentinas-rational-default
8) Bronstein, Hugh. “Argentina calls on US government to intervene in debt case.” Reuters. Available at: http://www.reuters.com/article/2014/08/11/us-argentina-debt-idUSKBN0GB1L920140811
9) “Will Argentina’s default unleash further contagion?” Knowledge at Wharton. Available at:http://knowledge.wharton.upenn.edu/article/will-argentina-default-unleash-contagion/
