The Argentine crisis that isn’t

 Argentina is now in technical default. At the request of three separate individuals, here is an explanation of why that doesn’t matter. 

You heard right. It does not matter. I have refrained from blogging about Puerto Rico, which does matter, because I have a conflict of interest. But the Argentine crisis is just not that important. In fact, the Argentine default barely matters for Argentines, let alone anyone else. (For those of you tracking these things, we stated that the whole thing did not matter back in 2012.)

First and foremost, this has to be among the world’s most-predicted financial crises. There will be losses, of course, but nothing systematic. Moreover, most of the owners of the restructured debt are pretty happy: it is still worth a lot more than they paid. 

Second, it really is not clear that there will be much of an immediate impact on Argentina. The most immediate fear is that 25% of the bondholders will call their bonds. (See page 162 and page 205; for an abriged version of the 2010 restructuring that pulled in a lot of the remaining holdouts go here.) But that is not likely. Why not? Well, for every minute that Argentina is in default, the unpaid coupons accrue interest at an annual rate of 8.28%. Where else can you earn that these days? 

Otherwise, well, Argentina is already locked out of foreign financial markets. It is true that the government is running a relatively small deficit. But it is domestically-financed now and will be domestically-financed in the future. The new bonds it will issue to pay expropriation claims will not be directly affected unless the U.S. courts expand their ruling (which is possible, but unlikely); the effective interest rates that Argentina will need to pay on them won’t rise much.

It is true that it will be hard for Argentina to find a workaround to pay the bondholders. No bank that does business in the U.S. will want to touch the funds. But Argentina can keep paying into an escrow account and just wait for the pot to get large enough to convince the bondholders that they may as well pay the holdouts themselves. 

Now, there will be some costs. Argentina has almost $6 billion in debt that it will need to roll over this year, followed by another $10 billion in 2015. That will now be more expensive. 

Moreover, the Argentine economy is in trouble for reasons unrelated to the legal battle over the debt.

But the fact is that the Argentine Republic is not the United States. This particular form of default, while never certain, was always high-probability and Argentina can live without access to foreign capital markets. In short, interesting but not important.

Comments

[FS]

"Why not? Well, for every minute that Argentina is in default, the unpaid coupons accrue interest at an annual rate of 8.28%." That is a fair point as it relates to accelerating the discount bonds. However, what about the par bonds (2038 bonds)? It seems (though not 100% sure) that they can be cross accelerated, they're only trading at 51 cents on the dollar and their coupon is only 2.5%. Thoughts?

[Noel Maurer]

Great question!

I did some checking; the par bonds can be accelerated if 25% of their holders so choose.

The yield on the par bonds is only around 5%, but that's still not nothing. I don't think the par bond holders would so choose, given the risk.

What risk, you ask? Well, should the bonds be accelerated (i.e., "called" in layperson's langugage), then it's quite likely that the Argentine government will just throw up its hands and remain in default. If that happens, then the value of the par bonds will drop by at least half. (Historically, Latin American bonds in default traded for about 25% of par.) That would be ugly.

Another possibility is that the Argentines could just mail physical checks to the bondholders. Those checks could not be cashed, of course, but the Argentines could then argue that the bonds were not in default and could not accelerated. I doubt that would hold up in court (and I can't imagine analysts or traders buying the logic) but it would slow any attempt to call the bonds.

If that's the counterfactual, better to just sit and collect the interest, I think. No?