Two fun things happened last week:
- Amazon announced a smartphone; and
- Argentina got trounced by the Supreme Court on a ruling about their sovereign bonds.
Now you might be reading those two points, and saying to me “Yeah, but there’s only one news item there that comes in 3D. Who the fox cares about sovereign bond rulings?”
This might be true – and the Amazon Fire Phone does have some fun dynamic imaging, even if the internet is full of reasons why the Amazon Fire Phone is going to fail (it’s too expensive, it’s too late, it’s too the same as everything else, etc). Here’s a picture of it:
But the Argentina bond story is financial gossip at its most juicy.
- In 1998, the Asian and Brazilian financial crises had hit the emerging markets hard, and their situations weren’t helped by the Dot Com bubble burst in 2000.
- Argentina in particular was hurt badly. After two waves of hyperinflation in the late 80s, Argentina had been propped up on IMF loans. But government corruption and massive tax evasion meant that those loans weren’t being serviced – so the IMF kept pouring in more money to cover government spending, and extending payment schedules in the vague hope that they would one day repay.
- Oh, and also, Argentina had pegged the peso to the US dollar (after all that hyperinflation, they had to instil faith in the peso somehow).
- Then those financial crises happened.
- Suddenly, Argentine debt was perceived as riskier just because.
- And the currency devaluations in Brazil suddenly made Argentinian exports very expensive for one of their major trading partners.
- In the midst of that stress, the IMF decided that this would be a good time to insist on austerity (the bastards).
- Eventually, even after unpopular wage cuts and much rioting, the IMF decided not to send a tranche of financing through to the Argentine government in December 2001, because the austerity just wasn’t big enough.
- This meant that on 11 December 2001, Argentina’s cost of debt was sitting at 42 percentage points above that of US treasuries.
- So Argentina defaulted.
- And its default announcement to its creditors sounded something like “Let’s swap out the bonds. We can afford to pay 35 cents back for every dollar we borrowed. So we’re going to exchange your old bonds for new bonds that pay exactly that. And we know that most of you will be okay with that – because the old bonds are currently trading at ±30 cents on the dollar. So if we do the swap, and make good on this new promise, those of you that bought the old bonds at 30 cents on the dollar will earn a tidy 17% return instantly. Let us know.”
- And most of the creditors said “That’s a good deal.”
- Because it’s not like the holders of Argentinian bonds at that point were all the people that had originally lent Argentina money. No – by then, there’d be a frantic sell-out, and the bonds were mostly held by high-risk-loving prospectors (and their funds) that had bought the bonds at 30c on the dollar.
- But not all the creditors did the swap.
- In particular, one “vulture fund” belonging to Elliott Associates had had great success with Peruvian bonds – they’d picked up the distressed Peruvian debt for $11.8 million, and then sued Peru’s government to settle for $56 million four years later (making an effective return of over 300%, once legal fees were paid). The reason for the settlement? Elliott threatened to seize Peruvian payments to current creditors through Peru’s clearing house in Belgium.
- So hoping to repeat their Peruvian successes, Elliott Associates bought up distressed Argentine debt at 20 cents on the dollar, and took the Argentine government to court in New York.
In case you’re interested, here’s what Elliott Associates argued:
You issued your bonds here in America and you made them subject to US law.
Because of that, included in your bond contract an awkward little latin clause called “pari passu”, which basically says that you have to treat all of your creditors equally.
Here’s our problem: when you pay the holders of your exchanged bonds, and you don’t pay the holders of your old bonds (you know, the people that didn’t take you up on the exchange), you’re not treating everyone equally.
So we’ve got this court order here against your US bank, the Bank of New York Mellon, that stops them from making any more payments to those other holders until you pay us what we’re due in back-payments to 2001.
Or in simple terms: pay us, or default again.
Did we mention that we hold those old bonds?
Yours, in credit
Elliott Associates AKA the vulture funds (haters be hatin’)
So after much legal stuff, here is where things stand:
- Argentina had been getting stays on various court rulings by appealing them (meaning that they could continue to make their repayments as they fell due).
- But last week, the Supreme Court decided not to hear Argentina’s appeal to the Supreme Court, meaning that the last ruling now stands, and there are no more stays to be had.
- Argentina has a payment due on Monday.
- But it can’t pay it, because Elliott has effectively blocked the Argentine Treasury from making any payments through the US financial system.
Argentina’s president Cristina Kirchner is apoplectic with rage, and is making all manner of statements about sovereignty (because, you know, Argentina has a right to pay who it wants regardless of what contracts it has made, and why should they be forced to honour them?).
Basically, there are three options left on the table:
- Settle with Elliott
- Pay the exchange bondholders in bitcoin
Vulture funds, eh? Mad crazy.
For a thoroughly entertaining view on what might happen next, read this article by Matt Levine.