Jayati Ghosh in Naked Capitalism (image from wikimedia commons):
Ever since it bought Argentine bonds at around 20 per cent of the face value in 2008, it has been pursuing the case both legally and physically. In 2012, it hired mercenaries to detain and try to seize an Argentine ship where it was docked off the coast of Ghana; at another time it even attempted to grab the Argentina Presidential plane from an airport—as “collateral” for its supposed holding of debt. Legally, NML Capital and another vulture fund, Aurelius Capital Management LP, have been pursuing a case in a New York district court, demanding full payment on their debt, of the value of around $1.5 billion. It has been estimated by the Argentine government that this could amount to a return of more than 1600 per cent on the initial investment made by these vulture funds.
In 2012, U.S. District Judge in New York Thomas Griesa ruled in favour of the hedge funds, which was both extraordinary in law and devastating in its potential implications not just for Argentina but for finance in general. The Argentine government appealed against it, but this appeal has now been dismissed by the U.S. Supreme Court.
Consider just some elements of this U.S. court decision. First, it is based on a peculiar and unprecedented interpretation of the pari passu (equal treatment) clause, which holds that all bond holders must be treated alike. The courts have interpreted this to mean that a sovereign debtor must make full payment on a defaulted claim if it makes any payments on restructured bonds. So if the bondholders who agreed to restructure 93 per cent of the Argentine debt are being paid according to their agreement, then the other resisting bond holders must also be paid the full value of their debts!
The immediate effect of this would be to disable Argentina from repaying $832 million of debt to other bondholders (who have already received around 90 per cent of their debt) unless it also pays the holdouts in full, thereby forcing the country into technical default. Economy Minister Alex Kicilloff noted in a speech to the United Nations that this contradicts Argentina’s own laws and its clear agreements with creditors in the restructuring process that it would not treat other creditors differently. An official statement from the Argentine government called this judgement “senseless and unheard of”, and pointed out that by attempting to block the payment, the judge “has abused his power and gone outside of his jurisdiction because the holders of restructured bonds are not the object of this litigation.”
This is effectively leaving the country no choice but default on its other legal obligations. “Not paying while having the resources and forcing a voluntary default is something that is not contemplated in Argentine law. It would be a clear violation of the debt prospects.”
This absurd interpretation of the pari passu clause does indeed have systemic implications. It effectively makes a mockery of all debt renegotiation agreements, since there would be no incentive for any creditor to accept less than full value of the debt if some other creditor will be paid in full. It is therefore also in contradiction to the United States’ own bankruptcy laws under Chapter 9 and Chapter 11. Indeed, bankruptcy laws are in place in most market economies precisely to ensure that there can be an orderly workout when debts cannot be repaid in full.
There is a reason for this. No credit system can function or has ever functioned with zero default. This possibility of default is embedded into credit contracts through the interest rate, with interest rate spreads operating as the market estimate of the probability of a default.