The Argentina Debt Case

By Jayati Ghosh, Professor of Economics and Chairperson at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Originally published in Frontline (India)

Almost everyone now knows that the world of international finance is not a particularly robust one, nor is it particularly just or fair. But it has just got even weirder and more fragile, if this can be imagined. A recent ruling of the U.S. Supreme Court, refusing to hear an appeal by the government of Argentine against a decision of a lower court on a case relating to its debt restructuring agreement with creditors over a decade ago, is not just a blow against the state and people of Argentina. It has the potential to undermine the entire system of cross-border debt that underlies global capitalism today.

The case has its origins in the 1990s, when the government of Carlos Menem fixed the Argentine peso at the value of one U.S. dollar, through a currency board arrangement that restricted base money supply to the amount of external reserves and sought to increase its spending through the build-up of external debt. This was obviously an unsustainable strategy, which exploded in a financial crisis in 2001, bringing on a major devaluation of the currency and a default on around $100 billion of external debt.

In 2005, the government of Nestor Kirchner, which had then managed to revive the economy to some extent, offered its creditors debt swaps that significantly restructured the debts. Since Argentine bonds were anyway trading at a fraction of their face value in the secondary market, this deal, which reduced the value of the debt by nearly 75 per cent, was acceptable to most of the multinational banks and other creditors. (Since unpaid interest is added on to the principal and compounded, the actual face value of the debt in such cases is typically much more than the amount originally borrowed or lent out.) Indeed, creditors holding 93 per cent of government bonds participated in the debt swaps of 2005 and 2010.

However, a tiny minority of creditors held out and refused to accept the negotiated settlement. These then sold their holdings to hedge funds (in this case known as “vulture funds” that take on distressed assets in the hope of recouping a higher value from them). One of the most prominent of these funds in the Argentine case is NML Capital, a subsidiary of Elliot Capital Management, which is run by U.S. billionaire and major Republican party donor Paul Singer. This fund has a history of using aggressive tactics to force struggling sovereign debtors to pay the full value of debts that have already been deeply discounted by the market. In the past, it has successfully sued the governments of Peru and the Democratic Republic of the Congo.

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. So those who are seen as less likely to be able to repay are forced to pay higher interest rates, in both formal and informal credit transactions. A creditor who has been demanding and receiving a higher interest rate based on this probability cannot then demand full repayment as a right, since the contract reflected that very likelihood. So the ruling actually negates the basic principles upon which all credit markets function. This is one reason why even columnist Martin Wolf of the Financial Times described this case as “extortion backed by the U.S. judiciary” (Financial Times 24 June 2014).

The U.S. court rulings go further, saying that any third party—including banks facilitating such transactions—that attempts to pay these bondholders would be held in contempt of court. Judge Griesa even ruled that a payment by Argentina to holders of a euro-denominated restructured bond was also illegal, even though that particular bond is denominated under English law, and not under U.S. jurisdiction.

Another extraordinary feature of the court judgment is the requirement that banks involved in handling the payments made to Argentine bond holders must turn over information to holdout bond holders on all the assets that the Argentine government holds worldwide. This is a major violation of banking secrecy laws everywhere, including in the United States. Even Justice Ruth Bader Ginsburg, a member in the Supreme Court’s group of justices deciding the case, was constrained to ask: “By what authorization does a court in the United States become a ‘clearinghouse for information’ about any and all property held by Argentina abroad?” A press release from UNCTAD noted that this also severely erodes sovereign immunity, which can even have adverse effects on the U.S. and may be illegal under other U.S. laws.

It is no surprise that even the IMF and the Obama administration in the U.S. have expressed concern over the systemic implications of this judgment on the operation of financial markets. The ripple effects of this judgment are likely to be felt for some time, affecting new (and inevitable) cases of restructuring of sovereign debt. There are unknown but probably vast amount of sovereign debt that is not governed by collective action clauses, and even such clauses cannot function if 25 per cent of creditors choose to hold out. Inability to enforce orderly restructuring is a recipe for the seizure or inaction of credit markets. Certainly it is an outcome that the already fragile global financial system can ill afford.

The obvious requirement is to move towards some internationally recognized system of debt restructuring, possibly along the lines of Chapter 9 bankruptcy laws in the U.S. that govern municipalities, or similar arrangements that recognize and give primacy to the rights of citizens rather than only creditors. It remains to be seen whether the current travails of Argentina will be enough to concentrate the minds of those who are in a position to initiate such a process.
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  1. Ben

    I didn’t read your whole article, but you are wrong about a few things.
    1) much of financial math is based on the assumption of a risk-free investment, the US bond. You can debate whether it is risk free or not, but the concept is prevalent and very important.
    2) Griesa did not bar payments to euro denominated bonds. Read the court transcript.
    I think the problem that Griesa addressed, that people are ignoring, is that the contract has specific wording. argentina voluntarily and purposefully made the bonds subject to New York law. For the judge to ignore what the contract has written is a strange request. Also, few bonds still have pari passu clauses. There are holdout thresholds. And even looking at pari passu bonds, the fact that investors can now believe that sovereign debt can be enforced should mean that while struggling countries may not want to have as large issuances, they should get better interest rates.

    1. toldjaso

      This case sheds light on why insurance, banking, and merchant banking were forbidden to live under the same roof. The question is, how was Rubin paid to eliminate Glass-Steagall? Many acts of treason were involved in the conjuring of this black swan of perfect perfidy. The “President” is NOT the commander.

    2. Alejandro

      “I think the problem that Griesa addressed, that people are ignoring, is that the contract has specific wording.”

      Also ignored is the persistent, recurrent historical reality that debts CAN and DO become unpayable, which makes “risk-free investment” sort of an oxymoron. Weren’t bankruptcy laws, once upon a time, a practical recognition of this reality?

    3. Yves Smith Post author

      It does help, when you are claimign to be out to correct the record, to have you facts straight. From Bloomberg as of 8:41 AM (as in right after you made your comment):

      Three weeks after President Cristina Fernandez de Kirchner sent $539 million to pay bondholders, the money remains in limbo as a U.S. court considers what to do with the funds.

      U.S. District Court Judge Thomas Griesa in Manhattan may rule today on whether custody banks can route payments to holders of bonds issued under European and Japanese law….

      Time is running out for Argentina to reach a settlement with holdout creditors from the nation’s 2001 default before a grace period on the bond payment expires at month’s end. Griesa, who blocked payments deposited with BNY Mellon because Argentina didn’t also set aside $1.5 billion it was ordered to pay the holdouts, is unlikely to let the funds clear, said Joshua Rosner, a bank analyst at Graham Fisher & Co.

      “In terms of releasing the exchange bondholders’ funds, I expect the judge will say no unless the holdouts and the government agree, and I can’t imagine that the holdouts will agree,” Rosner said in a telephone interview. “At this point this is a subterfuge. We have yet to see the government really suggesting a willingness to settle.”.

      Ghosh was right on this issue and you were not. The European bond payments were held up as of when he wrote the article. And it is not clear what Griesa will rule when he rules.

      1. Cal

        Maybe the “out” for Kirchner is to pay the Euro bill by transacting completely outside the US banking system. Dunno how that would be done, but it would get the issue beyond reach of the court’s jurisdiction.

      2. Ben

        Thank you for the correction. Originally he didn’t block payment, but that was due to confusion as to which branch of BNY Mellon was taking the euro payment. (Truly, allowing euro-denominated bonds is in a court transcript.) Sorry for the misinformation.

      3. Ben

        I don’t intend to beat a dead horse, but an economist article just stated: “The price of dollar-denominated defaulted debt surged above face value after the Supreme Court’s ruling, opening up a gap with euro-denominated debt that is not subject to New York law” found here I find this confusing, can someone help me reconcile what’s going on? I’d like to understand the discrepancy in articles.

      4. Prospero

        Minor correction – Jayati Ghosh is a woman, so it should be “as of when she wrote the article”.

  2. Jim Haygood

    Good summary. A couple of assumptions deserve further examination:

    ‘A currency board arrangement that restricted base money supply to the amount of external reserves and sought to increase its spending through the build-up of external debt. This was obviously an unsustainable strategy.’

    Tough to summarize a decade in a sentence. But a currency board per se isn’t obviously unsustainable. Hong Kong has had one for decades. What sank Argentina were commodity prices which, in real terms, fell to 1930s levels in 1998 and again in 2001. With ag exports being its only internationally competitive sector, Argentina’s situation while tied to the booming U.S. resembled southern Europe’s plight tied to Germany. The late Nineties featured a roaring Internet bubble in the U.S. Argentina, having no tech sector and facing ruinously low prices for its exports, meanwhile was in deep recession.

    ‘A tiny minority of creditors held out and refused to accept the negotiated settlement. These then sold their holdings to hedge funds.’

    It’s not so simple. Hedge funds apparently are only a minority of holdouts:

    BUENOS AIRES—If President Cristina Kirchner opts to settle with two New York hedge funds that have won court-ordered awards of more than $1.5 billion, economists say it will most certainly lead to additional claims that will cost Argentina’s government about $13 billion.

    Thousands of individual pensioners and investors both in Argentina and abroad bought small amounts of Argentine bonds before the 2001 default.

    Italian lawyer Pietro Adami, who represents about 30 of the individual holders, stated “These aren’t vultures. They’re real people.”

    1. Jose

      Not only commodity prices fell – the dollar also rose. Having the peso tied in a currency board to a strong dollar severely worsened Argentina’s external balance problem.

      If the dollar had been weaker throughout the second half of the 90’s then perhaps the peg might have been sustainable, in the sense of not wrecking the Argentine economy.

      And a possibility never explored by the neoliberal government in Buenos Aires was asking for some sort of debt guarantee by the U.S. – similar to that recently provided to Ukrainian bonds denominated in dollars. That might have transformed Argentine debt into almost “risk-free”, with lower interest rates and thus increased “sustainability”.

      If the Cavallo team had come up with innovative ideas then maybe – just maybe – the currency board could have escaped its ignominious demise.

  3. Michael Hudson

    Speculation is that Singer bought CDS expecting Griesa to force Argentina into default. He may clean up much more on exercising these — as John Paulson did with his bet that junk mortgages would go bad, and cleaned up on CDS.
    How MUCH are the big TBTF New York banks on the hook for?
    A new bailout coming?

    1. Abe, NYC

      Thanks for the info, I think this is extremely important. Potentially could tip over the markets and have all sorts of cascading effects, couldn’t it?

  4. toldjaso

    NML is mean as hell. This is more than cunning price gouging. A base and perverse model is this, truly “diabolical” in its conception. It’s extraction with a vengeance. Why does the world not turn its back on such immoral practitioners as Paul Singer? It’s not the “money” that’s dirty.

    1. Jim Haygood

      Based on the WSJ’s report that NML’s bonds represent about one-eighth of all the holdouts, a majority of holdouts are likely to be individual original owners, mostly located in Argentina and Italy, who would rather hold out indefinitely rather than recognize a loss.

      This is not a very effective way to invest. Probably you know someone who bought internet stocks in 1999, then held on to the bitter bottom in 2002, insisting that the market owed them their money back.

      While these original-owner holdouts are perhaps guilty of poor judgment, their stance is far from diabolical. Indeed, the hedge funds are rendering them a service, if an eventual settlement establishes a model for the small holders to get paid.

      1. Alejandro

        Given Argentina’s tumultuous history, which Argentinians could afford to invest in bonds? There’s a long history of who benefits and who suffers.
        Just to be clear, Singer doesn’t give a shit about pensioners anywhere, here or there.

  5. Yancey Ward

    An ignorant essay, even by this blog’s standards. Griesa could only rule in Argentina’s favor by ignoring the laws under which Argentina issued the original bonds. It was really, really stupid of Argentina to sell the original bonds under those rules, but, at the time, Argentina would have found it even more difficult to borrow abroad.

    1. Synopticist

      If you don’t like this blog, you’re more than welcome to wave your little d*ck elsewhere.
      Yves has forgotten more about international finance than you’ll ever know.

      1. hunkerdown

        a) This wasn’t Yves’ article, and
        b) Syndication on NC should be treated as a starting point for discussion, not an endorsement. You still have to use your best judgment.

        1. hunkerdown

          Rather, it wasn’t Yves’ (or Lambert’s) authorship, please forgive my bad brainfingers.

  6. Communal Award

    Income = 100
    Expenses = 158
    How can Modi regime cover this 58% deficit?
    More taxes/more loans/sell off more assets/steal your money/confiscate your cash in banks/print more rupees?
    I’d recommend to scrap Rehabilitation Centers for your politicians (President/VP/Governors/Rajyasabha/MLCs).

  7. Matthew G. Saroff

    I’m beginning to think that the solution for the Argentine government needs to either declare the vulture funds bonds odious deb, or pass a law making this sort of extortion a crime, swear out complaints in Argentine court, and then offer bounties for the heads (living, or course) of the vulture firms.

    I favor the latter, since it does not forge new international law, but it DOES put the fear of God into the vulture banksters.

      1. hunkerdown

        I giggle at the thought. It’ll be great fun watching neolibs try “But but, because markets, but wait, um,” as their heads explode.

        Nah, they’ll just appeal to authority, as the early liberals demanded. Can’t shake loose oligarchy when the hopelessly mainstream are so busy role-playing 135 or 235 years ago, depending on their assigned camp.

  8. drfrank

    The important point in this piece is that about the consequences of the lack of a judicial procedure for adjusting sovereign debt, i.,e., a bankruptcy court – like process for restructure sovereign debt. Without this, debts will be restructured piecemeal and unfairly. And interest premiums for debts where no such process exists will be higher. I read the US Court decisions re Argentina’s New York bonds to mean in practice if not in law that the previous restructurings of 93% are illegal under the loan agreement. Certainly, it would be unfair for 93% to receive 75 cents on the dollar while 7% receive 100% of their claim with compound interest. Argentina has not been worried about paying the holdouts, it has all along been concerned not to lose the benefit of the bargain made with those who agreed to take the haircut in the restrucuture.

  9. Jim Haygood

    As anyone could have foreseen, today Judge Griesa flatly rejected Argentina’s request for a new stay:

    A hearing with Judge Thomas Griesa began in a very harsh tone for Argentina. Not surprisingly, in the first stage the magistrate refused to restore the stay requested by Argentina, and instead insisted that negotiations should continue with attorney Daniel Pollack, the mediator appointed for the case.

    “The negotiations must continue to reach a solution,” he said. The hearing takes place with eight days remaining until expiration of the grace period which could put Argentina in technical default. “It’s a critical time,” said the magistrate.

    1. Jim Haygood

      Here’s the judicial response to Argentina’s two rounds of full-page ads in the NYT, WaPo and WSJ:


      Let’s see how the Widow K. escalates in response to this fresh yanqui impertinence.

        1. toldjaso

          Da. Mean-as-hell TINA sadists can eat their hats. There’s an alternative in the works.

          “Suppose all the lions get up and go,
          And all the brooks and soldiers run away.”
          (From W.H. Auden’s “If I Could Tell You”

          Disobedience works, while morality pirouettes on point:
          “No More Mr. Nice Masochist.”
          Will Scotland be next?

  10. Banger

    My view is totally arbitrary–anything good for Paul Singer is bad for me. Having said that, I agree that we need a new way to settle these issues by creating an international system to restructure and forgive debt. If we don’t do something about debt pretty soon it will be an increasing break on both innovation and development.

    1. Susan the other

      The first rule should be that the collection fund vultures can have no more than their expenses above their purchase price. Debt and speculation are concepts so diametrically opposed that to combine them should be a felony.

      1. toldjaso

        sto: the sharpest knife in the rack. “A felony” it is de facto, if not yet de jure. Fiat!

    2. hunkerdown

      Perhaps we need one, but anyone trusted by the US political machinery to run it is trusted by US oligarchs and unfit for that bench.

      So we’re why the world can’t have nice things. What’s the second best option?

  11. Erick Borling

    Here’s something Randall Wray wrote about it. “I’m neither a lawyer nor a judge. I think that one of the perogatives of a sovereign is the ability to redenominate debts, and even to default on debts. This has been done thousands or tens of thousands of times throughout history. Any creditor who believed Argentina would forever and always make all promised dollar payments was a fool, and deserves to lose. Argentina should offer to pay down all dollar debts in pesos; and it should by all rights be allowed to use gunboats to take back its property from hedge funds. But again, I’m no lawyer.” – L. Randall Wray

    1. Howard Beale IV

      That would be amusing to watch Singer go apoplectic if Argentina did that. Guess he’s letting his NML lackeys run this show while he’s busy trying to ruin Compuware and EMC.

      1. hunkerdown

        Oh, so RSA Data Security works for *him*, oh ho oh ho. Hope the Gov of Argentina isn’t using BSAFE to keep their secrets…

    2. jonboinAR

      I shouldn’t say anything at all, having not studied it, but I don’t understand under what authority or by what means of execution a judge in New York State is able to tell the presumed sovereign state of Argentina what or what-not bonds it can default on or in what circumstances.

  12. /L

    How much of this foreign debt taking on by the Argentinian state was transferred to private interests to build up foreign assets?
    The Latin American debt crisis of the 80s was in general of that sort, and when the shit hit the fan its business as usual, the debt is socialized and the assets the debt bought of course remain in private hands. Not that anyone in the global finance system dident knows what was going on.

  13. Adam Levitin

    I wish people would stop holding out US Chapter 9 bankruptcy as a model. US Chapter 9 bankruptcy doesn’t work. It is rarely used: less than 250 times in the last 36 years, and mainly with tiny little podunk towns with stupid financial problems like loss of tax revenue from a tax on strip clubs being declared unconstitutional or the state shutting down an illegal speed trap on the interstate. It has only started to be used for larger entities in the last few years (Orange County aside, but most of Orange County is incorporated, so it isn’t such a big entity), and I think it is way to early to call it a success. To the extent that Chapter 9 works, it is because it creates a framework for negotiations, and sets up consensual deals. We have not seen a cramdown in a major Chapter 9 to my knowledge.

    The other issue with applying Chapter 9 internationally is that there is a tension between domestic creditors and constituencies and international creditors. One can imagine a regime that deals with international creditors, but they won’t want to compromise unless there are domestic cutbacks made. How on earth can that be negotiated? It’s really hard to see a sovereign negotiating its domestic budget with foreign investors. Greece had to do so, but it didn’t negotiated with the investors per se–it was dictated terms by European central bankers. Not so easy to do with a country that controls its own currency.

  14. RBHoughton

    When you come across someone like Paul Singer you need to deal with him on the level. He himself is using limited liability to avoid paying out on this sort of debt. Governments should assume the same defence, otherwise we’ll have Shylocks pealing off layer after layer of flesh on compound interest claims and poor people being pushed further into debt.

    It should come as no surprise that poverty does not decrease in the West – that happens in China not in the countries we have drawn to our side.

    Its the same with the silly thing about a company being a person. That so astonished even dedicated capitalists that no-one believed the new law meant what it said for over thirty years. It was only after that period that a Mr Solomons litigated for a judicial construction of the legal term and the world learned that companies are alive and have rights distinct from their directors and shareholders. The foolishness of this should make us laugh but there are merchants and politicians today who keep a straight face when speaking of it.

    The basic rule in contract law should be this – whatever exemptions and conditions that one party claims must be available to the other party.

    I have seen contracts between American and Chinese companies whereby the Chinese contractor, who has a few staff who speak English as a second language, signs his agreement to the English version being the definitive one. That version contains, in elegant inscrutable legalese, provisions that make the contract binding on the Chinese party but not on the American one.

    We say that trade is the means by which we will put an end to war but then we have mindless lawyers doing venal work for reward and it seems as the law presently stands neither the law nor their professional body cares about it. Its all just a jape to us. We used to talk of Yankee traders in 19th century, caveat emptor, but we are still exactly the same today.

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