For the second time in 13 years, Argentina has defaulted on its government debt payments after failing to reach a settlement with the so-called “holdout” bondholders Wednesday night.
Midnight Wednesday was the deadline of a thirty-day negotiation period during which Argentina was already in technical default, having been barred by a US Court from making its scheduled coupon payments in late June to restructured debt holders.
I covered the events leading up to the technical default in this article. Here’s a summary:
- In late 2001 Argentina defaulted on $144 billion of its government debt. It was in the midst of the 1998-2002 Argentine depression, which was itself a result of poor government policy.
- In 2005 and again in 2010, Argentina restructured its debts and offered bondholders swaps for new bonds at 30% of their original value in order to guarantee payment. Only 7% of investors opted out of the deal.
- These opt-outs are today’s holdouts and the ones taking Argentina to court are the “vulture funds.” Led by Elliot Management and Aurelius Capital Management, they want full payment based on the original terms. They are demanding $1.5 billion.
- During June of this year, US District Judge Thomas Griesa ruled that Argentina must pay all of its bondholders at the same time. Argentina claimed that it could not manage to do this. The country was dealt a huge blow when the US Supreme Court refused to take the case, thereby affirming Griesa’s ruling.
- When Griesa ordered payments to the restructured debt holders be returned to the Argentina the country entered technical default with a thirty-day period to negotiate a settlement.
- The issue is being hashed out in New York state courts because the capital markets associated with the bond transactions are located on Wall Street which is under New York’s jurisdiction. Former Argentine President Nestor Kirchner also transferred legal jurisdiction of the matter over to New York courts during the initial debt restructuring negotiations.
For missing the $539 million payments to the restructured debt holders once again, Argentina is now in a state of default. This was despite a last-ditch effort by private Argentine bankers to prevent default by offering to compensate the holdout hedge funds or to purchase their bonds at full value.
Used to employing the “vulture fund” disparager against the US hedge funds, the Argentine government is now saying it is the victim of an international “conspiracy.”
An article in The Guardian quoted Argentine cabinet chief minister Jorge Capitanich saying:
“To say we are in default is absurd trickery… If the judge is clearly an agent of the vulture funds, if the mediator is an agent of the vulture funds, if the judicial system is infiltrated by the vulture funds, then what kind of justice are you talking to me about?”
Capitanich also blamed the court-appointed mediator, Daniel Pollack, for the fallout in negotiations, calling him “incompetent.”
Griesa’s earlier ruling, which was affirmed directly by the Second Circuit court and indirectly by the Supreme Court, was based on what analysts have called a “narrow” interpretation of the pari passu clause. Essentially, this clause dictates that all creditors of the same debt or bond be treated equally: equal rights of payment, equal seniority, “equal footing” literally.
Argentina formed its case around the contractually-binding RUFO (rights upon future offers) clause. It bars Argentina from paying the holdouts any more than the 30 cents on the dollar that it is supposed to pay the restructured debt holders. If Argentina was to pay the “vulture funds” suing Argentina in court the full amount, the country’s leaders claim that all other holdout investors could demand similar payment. The total could come out to anywhere from $4 billion to $15 billion, according to Forbes.
This clause, however, expires at the end of this year, thereby opening up the possibility for future negotiations.
Economists agree that the default will further hurt the Argentine economy, which has suffered to a great degree under current President Cristina Kirchner. The country used to be South America’s second largest economy behind Brazil but has recently slid to third behind Colombia, a country that has been fighting a civil war for fifty years. Argentine’s inflation rate has soared to 20% per year and is on track to reach 40% this year. The peso will continue its fall, already down 25% against the dollar, and the default will make Argentine borrowing more difficult and foreign investment in Argentina scarcer.
It is estimated the Argentine GDP will contract by a minimum of 1-2% for the year because of the default and other economic factors.
The effect of this default on the US economy will most likely not be catastrophic or even major. The Dow Jones did shed over 300 points, a decline of 1.88%, on Thursday, but other issues like geopolitical risks in the Middle East, Eurozone troubles, and mixed company earnings reports contributed to the dismal trading day as well.
In comparison, Argentina’s stock market index, the Merval, lost a staggering 8.39% of its value on Thursday.
Despite all the legal and financial points to the contrary, the Argentine government maintains it is not in default since it did make the scheduled $539 billion payment in June.
On Friday afternoon the International Swaps and Derivatives Association (ISDA) will hold a hearing to determine whether the default–or failure of negotiations if one takes Argentina’s side–has triggered a “credit event,” whereby credit default swaps (CDSs) are now payable. CDSs are like insurance policies on investments, and their prices surged on Thursday.
If the ISDA rules that a “credit event” has occurred, then at least to the financial world Argentina will be in an official state of default.
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