The Edgy Optimist

Double Default

Argentina’s financial woes can be partly blamed on one New York hedge fund.

Argentine President Cristina Kirchner is willing to settle with bondholders, but they’re not budging.

Photo by Daniel Garcia/AFP/Getty Images

On July 30, Argentina failed to make a payment on some of its outstanding sovereign debt. Which means that for the second time since 2001, Argentina has done what is increasingly rare for sovereign countries in the world today: defaulted on its debt.

That is the simple version of the story. The more complicated version involves the decade-long fight between the Argentine government and a U.S. hedge fund, Elliott Management, that has refused—almost alone among all the many holders of Argentine bonds—to participate in a restructuring of that debt.

The tale is labyrinthine, but there should be only one legitimate outcome: No sovereign government should be forced to accede to a handful of investors solely for the purpose of enriching those investors.

There are those in the financial community who reject that statement. They hold that the sanctity and enforceability of debt covenants is the vital glue keeping the financial system functional, and that once that principle is violated, it is a license for governments and indeed any institution or individual to renege on their obligations.

In many ways, that is true. But it is equally true that, consistently and for good reason, debt obligations are forgiven, restructured, or renegotiated in the interests of all. The battle between a New York hedge fund and the government of Argentina has no heroes, but 40 million Argentines and their financially feckless government should not be forced to enrich a few American billionaires who have refused to be slightly less enriched by accepting a reduced payment.

Paul Singer’s Elliott Management, along with a few others such as Aurelius Management (run by a former Elliott employee), holds at most 5 percent of the outstanding debt in question. That debt originated during Argentina’s last bond crisis in 2001, when the country defaulted on $95 billion in debt. Over the next years, and especially in 2005, the government of Argentina renegotiated the value of the defaulted bonds to pay creditors a portion of what they were owed (at the time about 34 cents on the dollar, although later the bonds traded substantially higher—closer to 70 cents on the dollar) and redeemed billions of the outstanding debt.*

The vast majority of holders agreed to the settlement. But a few refused to agree to these smaller payouts, among them Elliott Management and its subsidiary. The total amount of the bonds held by Elliott, et al. have a face value of more than $1 billion, but Elliott and Singer paid nowhere near that to acquire them. The subsidiary that purchased some of them in 2008 paid $48.7 million for a $220 million tranche, or just about 20 cents for each dollar of debt. The rest of the holdings were bought for a similarly heavily discounted price. If these holders accepted what the market was paying for these bonds, they would still reap an enormous profit. But that, apparently, is not sufficient.

As many have documented (and kudos to Felix Salmon for his intensive coverage in the past year), Elliott and Singer have made a lucrative business of buying distressed assets at pennies on the dollar. They then either see those holdings soar once a crisis has passed or soar after having pursued legal action to force the issuer of the bonds to pay in full—including a case against the government of Peru several years ago, which netted Elliott more than 100 percent return on its holdings.

A flashpoint of the current crisis came when a judge in the federal District Court of New York ordered that Argentina could not pay any of its bondholders unless it paid in full to the holdouts. The current Argentine government, represented by finance minister Axel Kicillof, responded on July 30 by saying that it welcomed further negotiations to settle these disputes, but that it would not cave to “vulture” investors who would compromise the country’s sovereignty and financial integrity.

Argentina is a hard case. Its government has a long history of fiscal irresponsibility, including not just the 2001 default but a 20th-century Peronist legacy of currency devaluation and repeated peso crises. Cristina Kirchner’s current government has shown an aggressive disdain for international financial institutions that have provided her government with repeated lifelines, including the IMF. And her response to uncomfortable facts about Argentina’s many economic shortcomings has been not only to blame the messenger, but to fire it. In 2007, Kirchner’s husband and then-President Néstor Kirchner dismissed the government statistical agency staff for reporting higher inflation than he wished. That almost led to Argentina’s suspension from the IMF, until Cristina Kirchner last year agreed to restore a more neutral statistical agency. Not surprisingly, this agency reported that inflation is indeed high.

But Argentina’s profligacy and questionable fealty to facts have never been secrets to international lenders. Nor should they mean that Argentina must be forced to meet the demands of a few holdouts.

The sanctity of bond agreements is a vital principle. But like with all principles, there are always viable and necessary exceptions to the rule. When Greece—whose own corruption and profligacy were well-known—nearly defaulted in 2010 and 2011, that default was halted by a settlement negotiated by several international institutions and forced on reluctant bondholders in order to preserve the European Union. In 2009 the Obama administration essentially coerced bond holdouts when it bailed out Chrysler and General Motors (which still enrages some on Wall Street). And the financial world is littered with bondholders taking only a portion of their original investment in lieu of taking nothing.

Argentina’s government is fully prepared to settle—and indeed already has settled—with most of the holders of the original $95 billion in debt as of 2001. Elliott and the other holdouts, who purchased those bonds later for a vastly lower price, would still find themselves reaping a considerable profit if they accepted the original settlements. What they have litigated for is to make an even more considerable profit, and they have spent many millions in legal fees in order to generate several hundred million extra in payouts.

This isn’t a simple case of a profligate and dishonest government refusing to honor its obligations at the expense of investors who had every reason to expect either full payment or a legitimate portion. This is a case of a profligate and dishonest government willing and able to pay a few hedge funds hundreds of millions of dollars and those funds saying no, we demand more.

The refusal of Elliott and Singer and co. to settle on those terms is not a brave stand for the sanctity of contracts and covenants. It is an act of greed. They may have legal standing to defend that act of greed. But they can defend it only at the expense of the integrity of a financial system that at times may be fueled by greed, but that can never allow it to become king.

*Correction, Aug. 4, 2014: The original version of this article misstated that the Argentine government renegotiated the value of defaulted bonds in 2005 to pay creditors about 70 cents on the dollar. The accurate figure at the time was about 34 cents on the dollar. (Return.)