Argentina's 13-year fight with creditors erupted in U.S. courts last week, and the results were messy.
Argentina had asked the U.S. Supreme Court to overturn a lower court's ruling that it must pay $1.5 billion to hedge funds for bonds Argentina had defaulted on in 2001. The Supreme Court refused to hear its appeal — a victory for the hedge fund investors whom Argentina's president, Cristina Fernandez, had called "vultures."
Fernandez had said Argentina couldn't afford to fully pay the hedge funds while also making payments to other lenders. But late last week, signs of a possible resolution emerged. Fernandez said she would seek a U.S. judge's support for resolving all of Argentina's unpaid debts in one grand bargain.
Her note of conciliation helped lift prices of Argentine bonds. Still, dangers remain. The ruling said that if Argentina didn't give the plaintiffs all the money they're due, it couldn't use U.S. banks to make its other interest payments, which are due June 30.
One misstep and Argentina could slide toward another default, which would likely spread trouble beyond its shores.
Just how did Argentina wind up in this mess? Here are some questions and answers:
Q: What happened after the Supreme Court turned Argentina down?
A: A lot. The Supreme Court also decided to let bondholders subpoena banks in U.S. courts to track down Argentina's assets abroad. The decisions drove the country's Merval stock index down 11 percent on Monday.
The next day, the rating agency Standard & Poor's cut Argentina's rating further into junk territory — to CCC-, S&P's lowest grade for any country.
For most countries, the rating agency's move would be a harsh blow. It would inflate borrowing costs and make it harder to finance budgets. But Argentina's troubles are so well-known that the downgrade came as little surprise. Argentina hasn't borrowed from the bond markets since its default in 2001.
Q: Who are the players?
A: In one corner, Argentina's government. In the other, a group of investors led by NML Capital, a subsidiary of Elliot Capital Management, run by billionaire Paul Singer. Singer, a lawyer by training, has in the past successfully sued the governments of Peru and the Republic of the Congo to make good on their bonds. In this case, NML and other funds bought bonds left from Argentina's default in 2001.
Q: What do they want?
A: When the hedge funds bought the defaulted bonds, they joined the ranks of Argentina's creditors. Now, like lenders everywhere, they want the borrower to repay its debts on the original terms.
Problem is, other creditors had already agreed to cut Argentina a break in 2005 and 2010 by swapping their bonds for new ones worth less. This helped Argentina's government slash its debts.
The bonds acquired by Singer's group were among those left over. In 2012, U.S. District Judge Thomas Griesa in New York ordered Argentina to pay the holdouts. They're now owed $1.5 billion in principal and interest.
Q: Why is a US court telling a foreign government what to do?
A: When a big business goes bust, it winds up in bankruptcy court. By contrast, sovereign countries have no dedicated international court to help them strike deals with creditors. So in agreements involving bond sales, language typically stipulates that any legal battle must occur in one of the two biggest financial capitals: New York or London. "That's where the money is," said Anna Gelpern, a professor of international law at Georgetown University and an expert on government debt.
Q: Why does this matter?
A: One worry is that forcing Argentina to pay the holdouts would set a dangerous precedent. The thinking is that it could encourage bondholders to play tough when struggling countries try to restructure their debts. Last week, the International Monetary Fund warned that the Supreme Court's decision could have far-reaching repercussions. "We are concerned about possible broader systemic implications," the IMF said.
Another concern is that the ruling upends the usual order of things. In the past, when some creditors had to take precedence over others, sovereign governments typically came before investment funds, said Mark Blyth, a professor of international political economy at Brown University.
"The old hierarchy really no longer applies," he said.
In negotiating with lenders, governments had the threat of default on their side. Creditors accepted restructuring deals in the certainty that they would at least receive something. Now, it seems, "the courts are taking away the possibility of default," Blyth said. "It's part of this wider push to put investors ahead of everyone else."
Q: How big is Argentina's economy?
A: It's South America's second-largest behind Brazil, according to the IMF. The IMF puts the country's economic output for this year at $404 billion, or $9,639 a person. By contrast, the United States has a $17 trillion economy, or $55,000 a person, according to the IMF's data.
Q: Argentina isn't poor. Why doesn't the government just pay off the holdouts and be finished with them?
A: It's not that simple. Argentina is supposed to make an interest payment to bondholders June 30, and the judge's verdict requires it to pay the holdouts their $1.5 billion at the same time. If that were the entire bill, it wouldn't be a problem.
"$1.5 billion isn't going to break Argentina," said Siobhan Morden, head of Latin American strategy at the investment bank Jefferies. "The problem is all the other litigants that could join in."
Paying the hedge funds in full would likely trigger lawsuits from other bondholders demanding to be paid on similar terms. Buenos Aires estimates that the liability could run up to $15 billion. Morden said it could approach $20 billion.
With nearly $29 billion in foreign reserves, Argentina appears to have the money to pay its bills. But those reserves include loans to other countries, deposits with the IMF and other assets that aren't easily used. Take those away, and Argentina has roughly $16 billion on hand.
Troubled countries often find bond investors willing to lend to them to pay other creditors. But Argentina has been locked out of the bond markets for more than a decade. Some investors would probably step up to lend it money — at painfully high interest rates.
"You can see why they have some financial reservations about paying the holdouts," Morden said.
Q: How are traders treating Argentina?
A: They're keeping a safe distance. Judging by recent trading, bond buyers seem to think another default is imminent. In the market for credit default swaps, Argentina's government debt is among the most expensive to insure in the world.
To insure $10 million in Argentine bonds for five years, investors must pay $4.4 million up front, then an additional $500,000 a year, according to Markit, a data provider. Those figures imply a 71 percent chance that Argentina will default within five years.
Taking out insurance on debt from Brazil looks cheap in comparison. The cost to insure Brazil's debt runs $139,000 for five years, and investors have to pay nothing up front.
Q: So if Argentina defaulted on its debts again, would it spread turmoil to other countries?
A: Probably not. Argentina is already isolated from the credit markets, the usual route for financial turmoil to spread, because traders have been wary of just such a threat.
A default could still have a troubling effect on some other countries. Gelpern said her concern is that Argentina's experience would make it harder for smaller countries to emerge from trouble. "Other weaker countries can't afford to wage fights for 13 years," she said.