The story of Argentina’s recent debt default begins in the Great Depression. Not our Great Depression – their Great Depression, which started in 1998 and ended in 2002.
Leading up to the crisis, the Argentinian government massively over-borrowed and was forced to default on their bonds when the country fell into financial crisis – the economy shrank by 20 percent, unemployment rose to 25 percent, bank deposits were seized, the currency collapsed and rioting ensued.
At that time, the Argentinian government offered a unilateral deal to creditors in 2001: we’ll pay you 33 cents on the dollar or you get nothing.
Almost 93 percent of the bond holders accepted the deal (something is better than nothing), but a small group of holdouts decided that a unilateral deal was unfair and they would rather sit on their bonds, take the Argentina government to court and see what happened.
As small group of hedge funds purchased the bonds at some point and took over the legal case against the Argentinean government. It took years for the case to wind its way through our legal system, but the courts said that the Argentines should pay the debt back and the Supreme Court refused to hear Argentina’s last appeal in June.
After a 30 day grace period in July, the bonds officially went into default and ratings agencies like Standard & Poor’s placed the country in ‘selected’ default. There will be no riots this time, but when a government (or anyone else) doesn’t pay its debt, it’s a default.
Since you don’t own any Argentinian bonds, you may be wondering why this matters to you.
At stake is a legal question about the meaning of ‘pari passue.’ It’s a legal phrase that means ‘proportionally; at an equal pace; without preference’ according to Wikipedia (heck, I’m not a lawyer!).
In this case, the hedge funds argued that equal treatment meant that borrowers (Argentina in this case) have to treat all bondholders the same. You can’t pay some back and not others, or, if the borrower paid back some of the money it had to pay back all of the money.
That’s not how debt restructuring typically takes place. Generally, a restructuring (a nice euphemism) means that the debtor and creditor get together and rework the terms: a longer time period, a lower interest rate, less principle, etc. That happens all the time in bankruptcy court, but there is no such thing when it comes to sovereign debt (debt issued by governments).
In a sense, the court ruling strengthens the hand of bondholders because the US is essentially saying that the terms of the deal must be enforced and unilateral deals aren’t acceptable.
One the other hand, it may make it harder for foreign countries to sell their bonds overseas, something that’s important to everyone, including the US given that a huge chunk of our debt is held by foreigners. It should make the cost of debt higher for everyone since its long been commonly accepted that restructuring would occur for anyone in troubled waters.
In the short run, though, there’s really no impact for investors. The markets have seen this lawsuit traveling through the system for years and there are no signs that if this domino falls, others will follow.