Bondholders Shockingly Expect to Be Repaid

Argentine Foreign Affairs Minister Hecto

Argentine Foreign Affairs Minister Héctor Timerman.

Oh, Argentina. First you lose the World Cup. Now you’re hurtling towards a sovereign debt default. What else is left to do but to blame it all on evil hedge funds? At least you’ve got a readymade villain: Paul Singer of Elliott Management, who rivals George Soros as the bête noire of international finance.

Some background: Argentina defaulted on $95 billion of debt in 2001. Four years later, they made a unilateral take-it-or-leave it offer, telling bondholders that those who didn’t take it would receive nothing. Five years later, Argentina made another offer, trying to entice those who didn’t bite on the first offer. They eventually got investors holding approximately 93 percent of the bonds to agreed to a deal that would pay around 33 cents on the dollar. But that left some 61,000 bondholders still owed money, many of whom paid par and did not collect a cent in what’s now nearing 13 years. That minority—led by Elliott subsidiary NML Capital—declined both offers and sued for full repayment. They’ve been fighting over it ever since, with Argentina’s last offer to the holdouts coming in at 20 cents on the dollar in early 2013.

On June 27, a U.S. federal judge called the country’s attempt to pay holders of that restructured debt before it had paid $1.5 billion in court awards to the holdouts illegal. The country had put $539 million on deposit with the Bank of New York Mellon Corp on the 26th to make a payment due on the 30th, but as a result of the ruling that payment was missed, starting the clock on a 30-day grace period before the country would default for the second time in 13 years.

And here we are today: On July 13, less than three weeks before that default, Argentine officials still haven’t met with the dissidents. It’s been more than five weeks since the Supreme Court ruled in the Elliott Group’s favor on every issue, but Argentina has yet to offer anything to the holdout group.

Predictions of the possible fallout of a default include the ruination of international capital markets and the permanent impoverishment of long-suffering Argentines. Neither is going to happen. In the meantime, though, the hyperbole has been downright entertaining.

I’m all for debt relief when disaster strikes a family or a community, but when it comes to finance ministers negotiating with institutional creditors, such grandstanding probably isn’t going to get you very far.

Exhibit A: In late 2012, after a judge in Ghana impounded an Argentine navy frigate at NML’s request, Argentina’s Minister of Foreign Affairs Héctor Timerman wrote on The Huffington Post that, “A piece of Argentina’s national patrimony has been detained, in clear violation of international law, in yet another attempt to cash out on speculative debt purchased for pennies in the wake of a default a decade ago.”

Let’s parse that for a second. By calling it “speculative debt,” the foreign minister was essentially saying that, “Hey, you knew there was a chance we might not pay you back. So stop complaining.” And then, with “default a decade ago,” he seems to suggest that the creditors should simply let it go because … well, because time heals all wounds. Or something like that.

Mr. Timerman continued: “The global economy allows debts to be traded like commodities.” Yes, that’s true. But it also allows countries to borrow billions of dollars that its own citizens might not be in a position to supply. “Vulture funds abuse the system, acquiring distressed debt in secondary profits to multiply profits at the expense of the poor and the weak.” I’m not sure how buying debt in the secondary market and then attempting to enforce its provisions constitutes “abuse,” but I’m quite sure he was playing to the crowd in using “the poor and the weak.” It was HuffPo, after all.

I’m all for debt relief when disaster strikes a family or a community, but when it comes to finance ministers negotiating with institutional creditors, such grandstanding probably isn’t going to get you very far. A better route would seem to be that taken by institutional investors who got burned buying all that CDO garbage off Wall Street banks in the lead-up to the credit crisis: Just admit that you were only pretending to do your job while pulling down the fat salary and then throw yourself at the mercy of the courts.

Then again, Mr. Timerman was only taking his cues from his country’s corner office. In June, when the U.S. Supreme Court denied the country’s appeal of a lower-court decision, Argentina’s President Cristina Kirchner referred to the dissident position as “extortion.” She has likewise vowed not to pay the recalcitrant bondholders, whom she calls “vulture funds.”

In his own bout of hyperbole, my old pal Felix Salmon recently posited that the U.S. courts were in the process of “upending international finance” and being “dangerous fundamentalists” by holding Argentina’s feet to the legal fire. That’s preposterous. If you want to borrow in the U.S., you should be prepared to have U.S. courts adjudicate any disputes.

To be fair, Mr. Salmon wasn’t exactly crying for Argentina, and he did point out that Argentina’s debt swaps with its more, shall we say, agreeable creditors were coercive. That’s one of the benefits of being a sovereign nation—you get to screw people over on a whim through this kind of swap or such time-honored traditions as the nationalization of foreign companies when you’re short a few pesos. (Or, if you’re Vladimir Putin, domestic ones.)

What’s at stake here is Argentina’s access to international capital markets, which the country has effectively
been shut out of since 2001.

What’s at stake here is Argentina’s access to international capital markets, which the country has effectively been shut out of since 2001. Argentina is already mired in recession and grappling with runaway inflation. A default would make things worse.

So what’s going to happen?

Argentina says it doesn’t want to pay the holdouts for fear of sparking other creditor claims—Economy Minister Axel Kicillof has estimated they could reach $15 billion—and bankrupting the country. At the same time, Ms. Kirchner and her late husband were credited for keeping Argentina on the up-and-up after the 2001 default, the largest in history at the time (Lehman surpassed it), and it seems unlikely she’d want her final act to bring the country right back to where she started.

Recent actions suggest as much: The country has already compensated Spain’s Repsol to the tune of $5 billion for seizing its controlling stake in oil company YPF. And in May it settled with the Paris Club of creditors by paying $9.5 billion. And while its stockpile of reserves has fallen from $53 billion in January 2011 to $29 billion today, the remaining $1.5 billion (or even $15 billion) wouldn’t break the bank.

As for Mr. Singer, he’ll likely settle. Matt Levine of Bloomberg View points out that Elliott’s leverage diminishes in the event of a default, so he’s motivated to avoid that outcome, even if he’s still got his poker face on today. On the other hand, if Argentina does default, billions in additional debt — and lots of angry bondholders — would be added to the 61,000 already in the holdout camp. The debt doesn’t simply disappear — Argentina will still have to come to the table at some point if it wants to operate in the global financial system.

We’ve seen this movie before. In 1996, Mr. Singer bought $20.7 million of defaulted debt issued by Peru for $11.4 million, sued the country, and in 2000 settled for $58.5 million. In the 1990s, he bought up $30 million of defaulted debt issued by the Republic of Congo for $10 million, sued, and settled for $127 million. He’s not going to be repaid in full. But he’ll make enough of a profit to ensure that his reputation for toughness remains intact.

When they’re not blaming the U.S. for trying to enforce its own laws, critics of the court are sounding the alarm that in forcing Argentina to the table, the U.S. risks losing capital market share to other jurisdictions where the legal options for creditors are more lax. Bull. There are reasons the U.S. debt market is the largest and most liquid in the world, and one of the most important is the legal framework. Argentina can blame Mr. Singer for its troubles if it wants to, but it’s not going to change a thing. If borrowers want to borrow in the U.S. market, they’re going to have to play by U.S. rules.