After Argentina defaulted on its sovereign debt back in 2001, it took an approach that many at the time described as hard line. It offered investors the choice of 30 percent of their money back, or none of their money back.
“They stepped on a lot of toes,” says Win Thin, Global head of Emerging Markets strategy for Brown Brothers Harriman.
Though many bondholders were upset, 92 percent agreed to the terms. A small group, primarily hedge funds, did not.
As Argentina began paying out diminutive returns to the creditors who agreed, the holdouts sued. They argued that as long as Argentina was paying some investors back, it was contractually obliged to pay the holdouts too – and to pay them the full amount of their debts.
Reading the relevant contracts narrowly, a lower U.S. court agreed, and in declining to hear the case the Supreme Court has allowed that ruling to stand. Argentina is now on the hook for more than a billion dollars and says it may now default. “If you look at the numbers they simply just can’t afford to pay this right now,” says Thin.
Argentina may negotiate with the holdouts, but after launching a campaign to vilify them as vultures, that may prove difficult. The next payment date for Argentina is June 30, and this represents the deadline for determining whether the country will default or reach some sort of agreement.
The situation is negative for Argentina’s economy, but unlikely to spread into some regional or global financial crisis, says Thin. Investors have generally stayed far away from Argentina since its default.
The global implications are still serious, according to many observers.
“The [International Monetary] Fund remains deeply concerned about the broad systemic implications that the lower court decision could have for the debt restructuring process in general,” said Gerry Rice, spokesman for the International Monetary Fund, in a briefing June 5.
Countries in distress have often used the same framework as did Argentina to extract themselves from default. Usually not quite as aggressively, but the principle is the same: obtain the consent of a majority or plurality of investors to take a haircut.
“The fear is when a country — whether it’s Greece or Portugal or what have you — is in a position where it can’t pay its debt, it’s rare that you ever get 100 percent of creditors accepting it,” says Peter Hakim, President Emeritus of the Inter-American Dialogue.
Requiring every defaulting country to obtain approval of all creditors could drag the process out or even dash it altogether, as creditors would now have an incentive to be the last holdout.
“You’re sort of messing with a system that’s working pretty well,” says Hakim. “The U.S. Treasury, although it didn’t formally join in the suit at all, has the same view, that this may interfere with the workings of the financial system.”
Others have more dire predictions.
“This case will impact debt restructuring all over the world, it’ll impact poor country access to credit,” says Eric LeCompte, Executive Director of Jubilee USA, a religiously backed organization that promotes global financial reform.
He says money earmarked for development is being diverted to pay creditors, to the detriment of vulnerable populations.
In one sense, the legal quarrel in Argentina’s case could have been avoided by a different type of contract, where new payment terms become binding for all investors if a certain proportion of them agrees to them.
However, for all the countries who have debt in the here and now, Argentina’s example is a warning that getting out of debt could is a lot harder than anyone thought.