Wednesday, December 5, 2012

Foreclosing on Argentina

You may remember all of the hand-wringing last year when there were fears that the United States would default on some of its debt if Congress didn't agree to raise the federal debt ceiling. All of that talk came to nothing when Congress and the White House agreed at the last minute to put off a decision until the end of this year.

Back in 2001 the nation of Argentina made the decision to default on their debt. Most debt holders agreed to accept about 30 cents on the dollar for their holdings. But not everyone. A few US-based hedge funds opted out of the agreement and held on to the debt.

Now, whenever you buy a bond you hand over a fistful of money to an entity that needs to borrow it. That entity agrees to pay you back the money you lent plus interest over a period of time. The interest paid on the bond is based upon the likelihood of repayment. The better your chances of getting paid back, the less interest you will earn (think savings bonds). But, interest rates rise as the risk of nonpayment rises.

Investors who purchased bonds issued by the Argentine government knew how risky their investment was based upon the interest rate to be paid on the bonds (for those of y'all who don't know how bonds work, when the price of a bond increases, the interest decreases, and vice versa). Those investors were more than willing to take their chances lending money to the Argentine government.

When the Argentine economy collapsed in the 1990's, the government had a hard time paying back investors as well as providing some level of services for the population. As things got worse the government made the decision to default on the bonds. When the government announced its decision to default on its debt, bondholders had a choice to make: they could either agree to negotiate a settlement on the bonds or they could hold on to worthless paper. Bondholders agreed to accept 30 cents for each dollar of debt they held. Except for a handful of US-based hedge funds.

These vultures swooped in and purchased the debt when the Argentine economy was in the dumps. They were betting that they could buy the bonds at a steep discount and cash out big down the road. Their plan depended on them receiving more than 30 cents on the dollar.

So the hedge fund operators sued the Argentine government in US federal court. In November a federal judge ruled that Argentina owed the hedge funds the full face value of the bonds - some $1.3 billion. And that bill comes due on the 15th of December.

But that decision raises more than a few questions dealing with national sovereignty and international finance. Maybe you're sympathetic with the vulture capitalists. But, what does it mean to national sovereignty if we allow a court in one country to tell the government of another country what they can and cannot do with their citizens' money? No one in Argentina elected that federal judge who has decided he has the authority to tell the Argentine government what it must do.

And, for those of y'all who don't see anything wrong with a US judge sticking his nose into Argentina's finances, how would you feel if a foreign government decided to tell our government how it could spend our tax money? Isn't that called taxation without representation?

These same vulture capitalists who preach that less government is better and that folks must be free to fail if we want our economy to grow, have no problem begging for a government handout when their billion dollar bet went south. Of course, what's more disturbing to me isn't that the vultures are hypocrites, it's that a judge decided he had the authority to order the Argentine government to repay the investors the face value of the bonds.

Talk about your moral hazard.

No comments: