The Argentine government recently defaulted on its external debt. The country’s debt issues had been building up for some time and then, just over ten years ago the country’s newly-elected president, Néstor Kirchner, rejected responsibility for the external debts his predecessors had recklessly accumulated.
Specifically, Argentina’s neoliberal regimes of the 1990s had tried to sustain the peso one-to-one with the dollar. To paraphrase Oscar Wilde’s comment on fox hunting, this was a case of the unspeakable in pursuit of the unsustainable. Quite sensibly, Kirchner felt no obligation for his government to honour this foolishly acquired debt, which had brought no benefit to the vast majority of Argentines.
Instead of completely cancelling the US$80 billion debt, the new Argentine government negotiated with creditors over the amount they would repay. Far from some transgression of basic values, such renegotiations of debt occur quite commonly among creditors and debtors, both public and private (when corporations declare bankruptcy, for instance). After several years agreement was reached with creditors holding over 90% of the debt to accept 30% repayment (to employ the current cliché, the creditors accepted a “hair cut”).
As these discussions proceeded, some hedge funds saw the possibility to make a fast buck (to use an old fashioned cliché) by purchasing Argentine debt with the intent to hold out for full payment. Foremost among these “vulture” debt speculators was MNL Capital that had bought its US$1.3 billion (face value) of bonds for far less than that amount, and far less than the 30% reached in the agreement. How much less we do not know because MNL Capital has not been notably forthcoming with such information (its website is a blank page with a small logo and nothing more).
To achieve their speculative end, the directors at MNL Capital “went to court” in New York state, where some of the Argentine bonds were sold (establishing jurisdiction for the case, NML Capital vs. Argentina). To the surprise of many if not most, the judge ruled in favor of MNL Capital, and the US Supreme Court declined to review the case (de facto endorsing the lower court decision).
Cash in hand
What makes this lender-borrower dispute rather unique is that the cash to meet the pending debt obligation (less than US$600m) sits in the Bank of New York Mellon ready for collection by the holders of the 90% of the debt that was renegotiated. The funds remain frozen in the Mellon bank because the judge in the case ruled that the Argentine government could pay no creditor without also paying the “holdouts” – the speculators in MNL Capital; ergo, we have default by the formal definition.
This is the first case I have ever encountered in which the borrower has made the necessary debt service payment, but the lender is prohibited from collecting it. Even the International Monetary Fund, always in favour of full payments of sovereign debts, described itself as “deeply concerned about the broad systemic implications” of NML Capital v Argentina, with a stronger criticism of the court decision made by Alicia Bárcena, head of the United Nations Economic Commission for Latin America and the Caribbean (CEPAL in Spanish).
The IMF’s concern is hardly surprising because if the New York court decision becomes generally accepted legal practice, many countries face financial disaster now or in the future. This disaster does not immediately threaten or even focus on Argentina. The danger lies in the longer term implications for sovereign debt management.
Willing and able
But, first, the impact on Argentina: according to the Guardian “it could add more pain for Argentinians, with the economy already in recession”. It would appear that most bond speculators disagree; Argentine bond prices have risen, not fallen, after the formal default.
The explanation should be obvious. The Argentine government wishes to pay the service on 90% of its debt, but is prevented from doing so by a court order. Any compos mentis speculator (aka “investor”) draws the obvious conclusion – the government is willing and financially able to service its debt.
Of course, the limited impact of the formal debt default does not mean all is well. Depending on your definition of “recession”, Argentina is either in it or will be soon. But either way, debt is not the major factor.
Inflation, Argentina’s dominant economic problem, has little to do with tension over the external debt (the economy has been prone to inflation, even the hyper version, for decades), and it is no great secret that the Argentine economy rises and falls with the fortunes of its much larger neighbor, Brazil (the former economy about US$500 billion, the latter US$2.3 trillion).
Follow the Leader: Argentina and Brazil
Real losers
Poor countries, especially those in Africa, are the real losers from this whole fiasco. Unlike Argentina with its relatively diversified economy and skilled labour force, the sub-Saharan countries have few options. Their underdeveloped financial sectors and near-total dependence on primary product exports leave them heavily reliant on foreign borrowing.
As catalogued by Daniel Huang in the Wall Street Journal (hardly an anti-business source), three sub-Saharan countries have infamously suffered assaults by hedge funds – Zambia (by Donegal International, not the Irish car rally and head office in the British Virgin Islands, no website), Democratic Republic of the Congo (FG Hemisphere, New York based, which has a website), and Republic of the Congo (Kensington International, Cayman Islands, no website).
The British government considered the first two of these so appalling that it over-ruled the court decisions granting the hedge funds their prey, the latter through the intervention of the Privy Council of England (apparently not all royalist relics are dysfunctional). Subsequently Parliament passed legislation to clip the wings and claws of the vultures.
There is a general principle in the affairs of finance – default by a small borrower is the debtor’s problem and default by a large borrower is the lender’s problem. During the Latin American debt crisis of the 1980s that principle was over-ruled by the US government, which prevented defaults by a variety of political and economic interventions.
The US government now lacks the power to do that again, and the rule is back in force. A global mechanism for sovereign default would make life easier for countries such as Argentina. For the poor countries of the earth it could be the difference between stagnation and development.