Argentina has been called a serial dead-beat country because of the way it dealt with bond markets. The nation was as wealthy as the U.S. at the turn of the 20th century, but over the century or so, it chose one disastrous economic path after another, which led to a number of defaults and restructurings of their sovereign debt. The last round came in 2001, but at that point, something interesting happened.
Instead of simply rolling over and taking whatever the Argentine government handed them, a number of investors dug in their heels and demanded their investments be made whole.
This stance took some moxy, since typically investors who hold out get clobbered. Defaulting governments tend to thumb their noses at such people, then give all the other investors new bonds worth a lot less money. The fact that a small group of investors chose to make this stand brings up some interesting points.
Not only should governments have to honor their contracts just like everyone else, but they have an even greater responsibility to make good on their promises than individual and private companies.
After all, these entities have the awesome power to levy taxes, incarcerate, and use military force. In return, citizens expect governments to follow the rules themselves as well as maintain the rule of law.
If people have to pay their debts, then so must governments.
The Thing About Bond Markets and Debt
While this might seem to be an obvious point, so was the fact that Argentina had proven to be a dubious borrower in the past, so investors weren’t willing to just fork over more cash.
When Argentina came back to the bond markets in the 1990s, creditors insisted on bonds that were issued in New York, away from the friendly courts and legal system of South America. This way, if anything went wrong, the investors could sue in U.S. courts.
When the inevitable happened, Argentina told the holdouts that they would get zip. Their prize for holding out and trying to force the country to pay its debts would be a complete loss of their investment.
The investors didn’t agree. They sued in New York, along with other places where Argentina had assets, and had two things on their side.
First, the bonds called for pari passu, in which all creditors have equal standing.
Second, the bonds did not contain a collective action clause (CAC) that would allow a supermajority of bondholders to dictate terms to the remaining holdout investors.
Eventually, the holdouts won in court, with the U.S. Supreme Court refusing to hear an appeal from Argentina.
There have been wild forecasts of how this will affect government bond issues around the world, with small groups of investors able to hold entire countries hostage. That’s nonsense, given that almost every bond issued now has a CAC.
While a sovereign nation was the loser in this case, it wasn’t exactly a win for the little guy.
The holdout group was made up primarily of hedge funds that bought up the debt when it was trading at very low discounts. They believed they had the force of law behind them to make Argentina pay back what they had borrowed.
It cost this group millions of dollars over the course of 13 years, as the two sides have been going back and forth in courts around the world.
Some people have suggested Argentina shouldn’t pay the group because they’re simply sophisticated investors with a savvy legal team. I disagree! A debt is a debt — and whether it’s owned by a nation or a private individual, it still must be settled. If the debtor has the ability to pay, it should pay.
This is a simple case of enforcing the rule of law and property rights, which all of us should be cheering, since it sets a much better example than allowing debtors to simply ignore what they owe and to treat one class of creditors differently than another.
Once companies or governments are allowed to pick winners and losers, we all lose. Investors would have no way of knowing ahead of time if, in a time of crisis, they would be singled out for favoritism or categorized as a loser. The result would be a drop in investment or cause the cost of investment dollars to rise, since investors would have to be compensated for an additional risk.
It’s good to see property rights finally get some respect, but it might not be long-lived.
With the Argentina case settled, the next big case will be the Detroit bankruptcy.
Given how U.S. courts treated GM investors, I’m not very hopeful that the Detroit case will work out any better.
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