If a person fails to pay you back for a loan, chances are you won’t lend them more money. This is exactly the situation the Argentine economy found itself in after it went bankrupt in the late 1980s but still wanted to issue bonds in the 1990s.
Now, the Argentine economy has defaulted again — for the second time since 2001 — last month on a record $95 billion of debt.
As you might imagine, potential buyers wanted some sort of guarantee that they would be paid, beyond the standard “full faith and credit” of a governrnment that had repudiated its debt more than once. So, in keeping with any good sales shtick, the country started sweetening the deals it made.
Their bond covenants were written with a pari passu clause, meaning all bondholders must be treated the same. This was a good start, but it didn’t clinch the deal for everyone. Eventually, Argentina decided to issue bonds in different jurisdictions to entice buyers, including some in the U.S.
The bonds were therefore subject to the laws of the jurisdiction in which they were issued. This gave many investors enough confidence in their rights as bondholders in the event something bad happened.
And that bad event happened in 2001. And now, 13 years later with a double shot of so-called swap-offers, the Argentine economy finds itself in another default.
We all know this story. It’s been in the news ad nauseam for months. In the mid-2000s, Argentina offered existing bondholders a take-it-or-leave-it deal (aka, swap-offers). They could exchange their bonds for new ones at a greatly reduced value, or they could receive nothing.
Many investors took the deal and started receiving their new interest payments. A few investors decided not to take the deal. They argued that Argentina had more than enough capital to make good on the old bonds, and should do so. Argentina refused.
The holdouts sued for payment, but not in Argentina. They sued in the jurisdiction in which the bonds were issued. For many, this was the U.S…. and that’s where the fight starts.
Argentina has refused to pay what they owe to the holdout bondholders for almost a decade. After eventually losing their case, Argentina appealed to the U.S. Supreme Court, which refused to hear the case.
A novel twist to this case is that because the bond agreement contains a pari passu clause, a U.S. judge determined that both the old bondholders and holdouts must be paid at the same time. Since they were all owners of the same original bonds, they cannot be treated differently.
The President of Argentina Cristina Fernrnandez de Kirchner, the Finance Minister Axel Kicillof, members of the media, and a myriad of others in the country have howled loudly about a U.S. judge trying to steal their money, or being in the pockets of vulture investors.
What they never seem to bring up is that the main reason the bonds were under U.S. law to begin with is because the country had already proven itself to be a deadbeat. It is difficult to see how investors who protect themselves and stand up for their rights — rights fully granted in the bond covenants as written by Argentina — are doing anything wrong.
As for those who think this situation could bleed over into other countries, potentially poisoning the finances of other developing countries with “vulture” investors holding these weak countries hostage, there isn’t much of a chance of that happening.
The countries in question would have to be either in default or at risk of default for this to ever come up. If countries that issue bonds actually pay their debts, then everyone gets exactly what they expect. Then there is the matter of jurisdiction.
If the bonds of a country nearing default are covered by that country’s laws, then chances are any settlement or bond exchange will be forced on all bondholders, with no recourse in the courts.
Finally, there is yet another bond clause that helps in such a situation, called the Collective Action Clause, or CAC. This clause allows any restructuring of debt that is agreed to by a majority of bondholders to be forced on any holdouts. As you might imagine, most bonds issued these days have a CAC, and I’m sure any future bonds issued by Argentina will certainly include one.
For now, the country proved itself too clever in how it issued bonds in the 1990s.
Argentina should step up to the negotiation table and make a deal, recognizing that bondholders are simply using the tools that were given to them.
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