Argentina Lets Default Clock Run Out

This story has been updated. 

Argentina missed a midnight deadline to either reach a deal with its creditors or begin paying them off. The country did neither, marking the eighth default in its history, but the story doesn’t end here.

"Anybody who’s hoping for closure when this negotiation ends [Wednesday night] will be disappointed," said Barbara Kotschwar, an economist who studies Latin America at the Peterson Institute for International Economics. "Even if we have a default, this isn’t over."

Argentina got to this point because it won’t pay the creditors that President Cristina Fernández de Kirchner has accused of extorting her country. In June, the U.S. Supreme Court refused to hear Argentina’s last appeal, compelling it to comply with a federal court order to pay the so-called "holdout" bondholders at least $1.33 billion. The holdouts are creditors who refused to accept lesser payments after Argentina’s 2001 default. Argentina has argued that it can’t afford to pay them and the 92 percent of creditors who previously agreed to exchange their bonds for cents on the dollar.

The financial press has rapaciously followed the cat-and-mouse game between Kirchner and hedge fund NML Capital for decades. Investors have tracked every twist of the intrigue as the bondholders have pursued Argentina’s assets from Buenos Aires to New York to Ghana. The raciest story in sovereign debt, for sure.

And the hours leading up to the July 30 midnight deadline haven’t disappointed. Although default was still widely expected Wednesday afternoon, the story line was filled with impromptu plot developments. In the morning, Argentina’s banking association, Adeba, reportedly was putting together a deal to buy the hedge funds’ bonds, according to the Wall Street Journal. By midday, Reuters reported that Argentine Economy Minister Axel Kicillof was spotted entering the court-appointed mediator’s office to try to strike an eleventh-hour deal. With every new development, Argentina’s investors saw hopes of averting default, and bonds bounced to new highs. Then, late Wednesday afternoon, ratings firms Standard & Poor’s cut Argentina’s rating to "selective default" as talks continued.

But no matter what happens, Argentines will have to deal with the consequences, which for Kirchner’s government may feel a little like the movie Groundhog Day. This default is inexorably tied to one in 2001 when the country stopped paying on $95 billion worth of bonds. Shocked Argentines stampeded to their banks only to learn that the government limited how much they could withdrawal. Then they watched with dismay as the peso’s value plummeted and their savings dwindled.

Luckily for Argentines, this time is not expected to be so bleak.

"Default is not as bad as it sounds for anybody who lived through the 1980s and 1990s and early 2000s," said Kotschwar. "It’s not ideal, but it wouldn’t be as devastating."

Economists are even more blasé about what effect another default would have on the international economy, partly because it has been a long time coming. Default has been a strong possibility since the Supreme Court ruled against Argentina in June, effectively putting an end to the country’s legal options.

"This is the slowest-motion train wreck ever," said Anna Gelpern, a Georgetown University law professor and expert on debt contracts. "If you didn’t see it coming, you’ve been living in a deep dark hole."

If Argentina defaults, bond values will likely fall, perhaps by as much as half, but probably not drop all the way to zero. That means they can be resold, and new bondholders will want to get paid. If Argentina wants to rejoin the international capital markets, it will have to find a settlement with those new creditors.

In 2001, the value of Argentina’s bonds fell to 30 percent of their original value. So-called "venture funds" thought that sounded like a pretty good deal, bought up the bonds, and then launched a protracted legal battle to make the Argentine government pay them the bonds’ full value, bringing the saga to this cliffhanger moment. Argentina could be back here in six to nine months, some observers say.

This lack of progress makes economists cry for Argentina. It has so much potential, they say; it has vast natural resources. But somehow, it can’t seem to get ahead.

"In the mid-1800s, Argentine GDP per capita was the same as the U.S. or Canada, but since then, it has consistently gone down," said Kotschwar.

The country’s willingness to renege on its debts — the pending default would be Argentina’s eighth — could scare off the foreign investors it needs to help develop its economy. Investors have flocked to Argentina nonetheless because of its abundant oil and gas resources, but some worry politics will now get in the way.

"The economics are boring. It’s so easy to figure out how to settle this. It’s the politics" that are the problem, said Robert Kahn, a senior fellow at the Council on Foreign Relations.

And default could even have a political upside, he said.

"After a default, they can blame their troubles on those nasty international markets and U.S. courts, when in fact these problems are all self-generated," Kahn said.