Argentina Defaults
Over the past few days, international attention has been drawn on the impending—and now realized—Argentinian default on its government bonds. This is the second time in just fourteen short years that Argentina has defaulted on its government debt, and, while there is never an opportune time for a national economic catastrophe, there are certainly better times than now. And that’s not just because of Argentina's tragic loss in the 2014 World Cup final against Germany in July! At the beginning of 2014, the country dipped into an economic recession with two consecutive quarters of negative growth. Government reserves have also been dwindling, contributing at least in part to the legal limbo in which the country now find itself yet again.
But this crisis is different than Argentina’s last default in 2001 and for one simple reason: it was clearly and unfairly imposed from abroad. Paul Singer and his New York City-based hedge fund won a long-running legal battle against Argentina in a Manhattan court in June that ordered the country to pay the firm in full—including years of interest—for debts defaulted upon in 2001. While the face value of the government bonds was originally $170 million, the hedge fund is seeking more than $1.5 billion, although according to JP Morgan Chase, the total bill for the country could add up to $13 billion should Argentina eventually recognize the claims and pay up.
Unfortunately, the circumstances as they have unfolded in Argentina reflect a profound misunderstanding, or perhaps ignorance, about what a loan entails in the first place. In its ideal form, a loan does not promise an unconditional offer of repayment; instead, the legal agreement incentivizes repayment while acknowledging that default can happen. In the case of Argentina, repayment is incentivized by the incredible harm that a government default does to both the Argentinian economy and its people through the international lack of confidence in Argentinian credit that it creates.
But defaults happen, and everyone—even Mr. Singer—knows it. Indeed, the risk of default, sovereign debt risk, is endogenous to international money markets through the use of interest rates commensurate with the perceived risk of loaning to specific governments. Or, said more simply: riskier debtors pay higher interest rates. That is to say that any creditor should be intimately aware of the political risk associated with their investment – and that they are compensated for it quite comfortably in the levels of interest that they do receive when more risky governments don’t default. Savvy investors pay a good premium for in-depth knowledge of the political constraints and risks in countries and regions in which they invest.
Thus, when Argentina defaulted in 2001 in the midst of one of its worst economic crises in history, the story of Mr. Singer’s investment in Argentina should have stopped there. He had made a bet on Argentina and had lost; if winning were guaranteed, the interest rate on the loan he wrote would not have been what it was. The absurd decision of the Manhattan court last month assures us of what we all already knew from our own recent economic crisis: when the country wins, banks win, and when the country loses, banks still win.