Screw turns on debt-ridden Argentina

By Matthew Craft

One mistake and South America’s second-largest economy could slide into another devastating default.

Argentina owes an interest payment to the majority of its creditors tomorrow. Photo / AP
Argentina owes an interest payment to the majority of its creditors tomorrow. Photo / AP

Time to resolve Argentina's long battle with creditors is running out.

Argentina owes an interest payment to the majority of its creditors tomorrow , though the government has a 30-day grace period to avoid going into another catastrophic default.

Last week the US Supreme Court ruled against Argentina, letting stand a lower court ruling that it must pay-off hedge funds that own bonds left over from the country's default in 2001.

President Cristina Fernandez has said Argentina couldn't afford to pay them while also making regular interest payments to other lenders.

On Saturday a federal judge pleaded with Argentina to continue negotiating with the hedge funds. At the same time, the judge called Argentina's attempt to make its regular interest payment illegal.

One mistake and Argentina could slide into another default, 13 years after a record US$100 billion ($114 billion) default devastated its economy.

Just how did Argentina wind up in this mess? And why is a US court telling another country what to do?

What happened after the Supreme Court turned Argentina down?

A lot. The Supreme Court also decided to let bondholders subpoena banks in US courts to track down Argentina's assets abroad. The decisions drove the country's Merval stock index down 11 per cent.

The next day, the rating agency Standard & Poor's cut Argentina's rating further into junk territory - to CCC-, S&P's lowest grade for any country.

Who are the players?

In one corner, Argentina's government. In the other, a group of investors led by NML Capital, a subsidiary of Elliot Capital Management, run by billionaire Paul Singer. A lawyer by training, Singer has in the past successfully sued the governments of Peru and the Republic of the Congo to make good on their bonds. In this case, NML and other funds bought bonds left from Argentina's default in 2001.

What do they want?

When the hedge funds bought the defaulted bonds, they joined the ranks of Argentina's creditors. Now, like lenders everywhere, they want the borrower to repay its debts on the original terms.

The problem is, other creditors had already agreed to cut Argentina a break in 2005 and 2010 by swapping their bonds for new ones worth much less. Investors traded in roughly 93 per cent of the defaulted bonds altogether, and this helped Argentina's government slash its debts.

The bonds acquired by Singer's group were among those left over. In 2012, US District Judge Thomas Griesa in New York ordered Argentina to pay the holdouts. They're now owed US$1.5 billion in principal and interest.

Why is a US court telling a foreign government what to do?

When a big business goes bust, it winds up in bankruptcy court. By contrast, sovereign countries have no dedicated international court to help them strike deals with creditors. So in agreements involving bond sales, language typically stipulates that any legal battle must occur in one of the two biggest financial capitals - New York or London.

Why does this matter?

One worry is that forcing Argentina to pay the holdouts would set a dangerous precedent. The thinking is that it could encourage bondholders to play tough when governments try to restructure their debts.

Another concern is that the ruling upends the usual order of things. In the past, when some creditors had to take precedence over others, sovereign governments typically came before investment funds, said Mark Blyth, a professor of international political economy at Brown University. "The old hierarchy really no longer applies."

How big is Argentina's economy?

It's South America's second-largest behind Brazil, according to the IMF, which puts the country's economic output for this year at US$404 billion, or US$9639 a person.

Argentina isn't poor. Why doesn't the government just pay off the holdouts?

It's not that simple. Argentina is supposed to make an interest payment to bondholders on June 30, and the judge's verdict requires it to pay the holdouts their US$1.5 billion at the same time. If that were the entire bill, it wouldn't be a problem.

Paying the hedge funds in full would likely trigger lawsuits from other bondholders demanding to be paid on similar terms. Buenos Aires estimates that the liability could run up to US$15 billion.

How are traders treating Argentina?

They're keeping a safe distance. Judging by recent trading, bond buyers seem to think another default is imminent. In the market for credit default swaps, Argentina's government debt is among the most expensive to insure in the world.

So if Argentina defaulted on its debts again, would it spread turmoil to other countries?

Not immediately. Argentina is already isolated from global credit markets, the usual route for financial turmoil to spread, because traders have been wary of just such a threat. But over the long term, a default could still cause problems for other countries. Anna Gelpern, a professor of international law at Georgetown University, said her concern was that Argentina's experience would make it harder for smaller countries to find a way out of their troubles.

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