For Part 1 of this series we will simply examine the background to the Argentine bond crises in laymans terms:
Argentina has long struggled with fiscal stability. By the time the Presidency of Carlos Mennem began in 1989, Argentina had previously defaulted on its debt 6 times since independence from Spain. The 1980s had been a period of very high inflation as Argentina monetized its national debt.
Monetization of debt is what happens when a country pays off its exists debt by issuing new currency. The new currency introduced into the system results in the weakening of the currency overall, and thus an increase in prices (think basic supply and demand.. by increasing the supply of currency while demand for it remains the same, the price (value) of the currency falls).
When Menem took office Argentina sought to prevent the hyperinflation of the 1980s from occurring again. The result was the Convertibility Law which pegged the currency so that the value of 1 Peso was 1 US dollar.
Under this system new pesos could not be created unless new dollars entered into the country. This limited the Argentine government from issuing Peso debt, spending the money, and then monetizing the debt by printing new pesos.
Rather than live within its economic means, Argentina decided to take another route. By issuing US dollar bonds in New York, it was able to bring dollars into Argentina, which allowed the government to then print an equivalent number of pesos that it could spend. By issuing bonds in New York and subjecting them to New York law, Argentina agreed that New York law would govern any disputes.
In 2002, faced with the worst economic crises in its history, Argentina defaulted on a wide number of its obligations, including the NY Issued bonds.
In 2005, Argentina began a debt restructuring. In 2005 76% of the dollar bondholders agreed to take new bonds worth roughly 30% of the original ones issues. In a second debt-swap in 2010 that number was increased to 93%. We will refer to these bondholders as the exchange bondholders.
7% of the bondholders did not agree to the exchange and demanded payment in full. These holdouts include a subsidiary of fabled hedge fund Elliot Management. We will refer to these bondholders as the holdouts.
For some years, Argentina has been making regular debt service payments to the exchange bondholders. However, this creates two problems for Argentina:
1. The original bond agreement states that all bondholders must be treated equally. That is, Argentina is not allowed to make payments to the exchange holders without also making payments to the holdouts.
2. The agreements made with the exchange holders states that if the holdouts receive more than the roughly 30 cents on the dollar that they received then the exchange holders need to be paid that much as well.
That is, Argentina cant just pay the holdouts the full amount to get them to go away without also paying the rest of the exchange bondholders the full amount.
Elliot sued in New York to keep BNY Mellon(Argentinas agent) from distributing funds to the exchange bondholders as the original bond contract states that all bondholders must be treated equally.
Elliot won this lawsuit. It was appealed to the Federal Court of Appeals which affirmed the New York judges ruling:
This is a contract case in which the Republic of Argentina refuses to pay certain holders of sovereign bonds issued under a 1994 Fiscal Agency Agreement (hereinafter, the “FAA” and the “FAA Bonds”). In order to enhance the marketability of the bonds, Argentina made a series of promises to the purchasers. Argentina promised periodic interest payments. Argentina promised that the bonds would be governed by New York law. Argentina promised that, in the event of default, unpaid interest and principal would become due in full. Argentina promised that any disputes concerning the bonds could be adjudicated in the courts of New York. Argentina promised that each bond would be transferrable and payable to the transferee, regardless of whether it was a university endowment, a so-called “vulture fund,” or a widow or an orphan. Finally, Argentina promised to treat the FAA Bonds at least equally with its other external indebtedness. As we have held, by defaulting on the Bonds, enacting legislation specifically forbidding future payment on them, and continuing to pay interest on subsequently issued debt, Argentina breached its promise of equal treatment.
The Supreme Court refused to hear the case.
With the case back in New York judge Griesas hands, BNY Mellon is prohibited from making interest payments on Argentinas behalf, and the exchange bonds are in default.
BNY Mellons UK subsidiary is also refusing to make payments on Argentinas behalf to the Euro Denominated bonds, despite not being under the jurisdiction of the New York court. This is the subject of a lawsuit by Euro denominated bondholders Kyle Bass and George Soros, discussed in Part 3.
Argentina has responded by promising a further exchange of bonds, this time offering the exchange bondholders another exchange whereby they will be issued new bonds in Argentina, and government by Argentine law. This creates a host of logistical problems, and so far the exchange bondholders have not expressed much of an opinion one way or the other.
In Part 2, we will discuss the failings in international law that have led to this crises.