Hedge Fund vs. Sovereign
How U.S. Courts Are Upending International Finance
The U.S. Supreme Court building in Washington. (Courtesy Reuters)
The case involved Argentina and a group of so-called vulture funds, led by the deep-pocketed and highly litigious hedge fund Elliott Associates, which was demanding repayment in full on old Argentine debt. Elliott had first come to broad public attention in 2000, when it brought -- and won -- a similar case against Peru. That unprecedented victory against a sovereign government, although worth a mere $90 million, so deeply shocked the international financial community that it prompted the International Monetary Fund to undertake a messy and protracted attempt to create a brand-new sovereign bankruptcy court. The Argentina case is much, much bigger -- Argentina owes Elliott over a billion dollars. The total amount that it owes “holdout creditors,” as the vulture funds are more formally known, is some $15 billion. Given that other holdout firms will immediately demand any terms awarded to Elliott, Argentina is not lying when it says that it simply can’t afford to do what the U.S. courts are demanding of it -- which is to pay all the holdouts in full.
Nor, of course, would it ever want to. Argentina defaulted on all of its foreign bonds in 2002, at the end of a depression that saw its economy shrink by 28 percent, its currency devalue enormously, and millions of its citizens lose their jobs and go hungry. At the time, it was the largest debt default the world had ever seen. (Lehman Brothers would eventually break that record.) Argentina’s foreign debt went unpaid until 2005, when the country offered its creditors a deal: Give us your old defaulted bonds and we’ll give you new bonds in return, with a lower face value. You should do that, because we’ll actually pay the money we owe on the new bonds. (This also hinted that it would remain in default on the old bonds.)
Argentina was true to its word, and, after a second bond swap was finished in 2010, some 93 percent of the holders of the original debt had swapped it out for what are known as “exchange bonds.” The swap was coercive, to be sure: bondholders didn’t have much say in the matter, beyond the choice of whether or not to participate. But that’s the way of sovereign debt. If a sovereign defaults, there’s not much creditors can do to force it to pay up. That’s what “sovereign” means. Traditionally, then, most bondholders have simply accepted any exchange offer they’re given. And, in turn, such exchanges have become an established means by which countries restructure their debts to avoid remaining in default indefinitely.
The case in New York -- the one that made it all the way to the Supreme Court -- was brought by bondholders that didn’t participate in the exchange. They originally bought their debt at a deep discount, and they knew how to apply past-due compound interest calculations to make the face value of the defaulted debt balloon into the billions. They knew that it wouldn’t be easy to get paid in full, but if they managed it they would have scored one of the biggest home runs in hedge-fund history.
Thus did the cat-and-mouse game between Elliott and Argentina begin: Elliott would try to seize Argentine assets, and Argentina would try to keep them out of Elliott’s reach. At one point, an Argentine naval sailing vessel, the Libertad, was confiscated by local authorities in Ghana, with the intention that it be handed over to Elliott. The ship was released only after a ruling from the International Tribunal for the Law of the Sea.
But behind all the legal shenanigans was a serious debate about sovereign bankruptcy, or, rather, about the fact that there’s no such thing as sovereign bankruptcy. Countries do not default lightly: doing so nearly always results in the government falling, and in the country being unable to borrow money abroad for many years to come. Since most countries run deficits, being able to borrow money is extremely important.
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