Argentine debt clash: Who blinks?

Blyth
Blyth

Argentina is in default again, but its latest predicament is far from your garden-variety sovereign debt crisis. This time South America’s second-largest economy has been tripped up not by new borrowing, but by a lawsuit from American hedge funds blocking settlements with bondholders over a 2001 default.
Shocking many, a New York judge this summer ordered banks in that state not to process Argentina’s payments to settlement creditors until it pays the hedge funds in full. When the country refused, it set up an international standoff involving banks and numerous other investors.
What does this have to do with Rhode Island? Possibly nothing. But then again, the Ocean State has spent the better part of two years debating its default options on an onerous, controversially structured debt connected to failed video game company 38 Studios. The precedent established in the Argentina case could presumably influence the legal relationship between governments and credit markets everywhere.
Mark Blyth, a professor of international political economy at Brown University, has been following the Argentina crisis.

PBN: As it stands, with the judge ordering Argentina to pay the hedge funds and Argentina refusing, what’s the next shoe to drop?
BLYTH: When the judge agreed with the hedge funds, the expected result was that there would be panic in the streets, the Argentine economy collapses and the government comes back to the table. But that hasn’t happened. In fact there was a surge in support for the president and surge in patriotic nationalism. And it raised a real sense of overreach – who does the United States think it is telling us what we can or can’t do with our creditors? – and raised the possibility of a currency swap with China, which they did after the announcement. The Argentine financial system hasn’t collapsed. There is still domestic savings. The economy is ticking along. What’s likely to happen is the hedge funds are laughing and congratulating themselves, but there are more creditors who are OK with the original settlement and they might not be willing to hold out, because they could see this dragging on. So they could be getting together to sue Bank of New York Mellon, which is holding the payment, and Bank of New York Mellon could then initiate legal proceedings to overturn the judge’s decision. That could be one way. Other than that everyone is playing a game of chicken, or maybe it’s more like a Mexican standoff. So long as Argentina’s internal markets aren’t collapsing, this could drag on for a while.

PBN: Is there an argument that what they are doing is somehow beneficial for the markets?
BLYTH: Oh certainly. It’s not one I personally feel holds much water, but it goes like this: The Argentines are serial defaulters and they want to borrow internationally; people lend them money but get taken to the cleaners time and time again. If we make it harder for them to do that, then they will be more serious in the market. Because it is harder to default, they will get a better interest rate, so they’ll need to tax their people less, creating better conditions for growth. The downside is that it turns the United States into the world’s bond cop, threatening to police every market by threatening not to release dollars in U.S. financial institutions.

PBN: Wasn’t Argentina’s credit history already priced into the bonds?
BLYTH: Exactly. There is a reason these guys get paid an interest rate. These hedge funds want a free option. They want an asset with serious unlimited upside and no downside. If you want Argentine debt, there is a reason you’re getting 10 percent. The reason you are getting 10 percent is not the alternate-use value of your money, which would get 1.5. percent.

PBN: What is the impact, if there is any, on average investors here in this country?
BLYTH: Let’s say you work at somewhere like, say, Brown University and your pension is invested in TIAA-CREF, which invests in global equities and bond markets. Some portion of their portfolio might be invested in developing-world bonds and may have some Argentine exposure. But even if it is, it is very small and even though the Argentine numbers are big, when you dissolve them into the capital pool of disaggregated credit portfolios, then nobody is really affected that much. You need to be a specialized investor in secondary debt of developing countries to really feel it.

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PBN: Is there any precedent here that could be extended beyond sovereign debt to other bond markets? BLYTH: I don’t know. That one relies in the province of the lawyers. Really, until we know the end game and how the law is written around this decision, then we can’t talk about what this is a precedent for. Another way this is playing out though is in the Atlantic trade agreement which is being discussed now behind closed doors. One reason it is happening behind closed doors is investor-protection clauses. Let’s say you invest in Scotland and they go independent and put in these strong environmental protections. A firm could say I have $100 million invested and this will cost us 10 cents on the dollar and sue for the difference.

PBN: One reason people in Rhode Island may follow this sort of thing more than others is the long-running debate over whether the state should default on the bonds for 38 Studios. Is it a stretch to look for any similarities?
BLYTH: Yes. And the most obvious difference is Rhode Island does not issue its own currency. You are defaulting in a currency you don’t control and you are subject to a higher sovereign. Argentina issues its own currency and is not subject to the laws of a higher sovereign.

PBN: And right now Argentina isn’t even using the international bond markets, right? So the threat they are going to be frozen out doesn’t mean much, while U.S. states rely very heavily on borrowing to provide services.
BLYTH: Right. They are already frozen out. The success cases right now are Portugal, who I think got back into the markets, and Ireland, which is back in the market. Of course, what people fail to mention with Ireland is they got back into the market but have quintupled their debt since the start of the crisis.

PBN: Where does this end up?
BLYTH: There is an election coming up and that will be a critical moment for Argentina, because that will be one of the key issues: what do they do about this ridiculous standoff? So I think the thing to look for is what happens in the run-up to and consequences of the presidential election. That’s when we will know how Argentina is going to play its cards. It is a bit like playing poker right now. •

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