The Fallout from Argentina’s Default

Argentina Flag

Last week Argentina defaulted on its debt for the second time in the last decade and a half. That’s not good news for investors who own international bonds, and headlines such as “Argentina’s default could hurt the world” and “Not just Argentina: 11 countries near bankruptcy” suggest that the Argentina’s travails could have a ripple effect around the globe. Despite the ominous headlines, however, the fallout is likely to be minimal.

To understand why, recall the series of events that led to Argentina’s most recent default. The country previously defaulted on its debt in 2001 following a severe recession that forced it to substantially devalue its currency. To get back in the good graces of global financial markets, in 2005 and then again in 2010 Argentina reached agreements with most of its creditors to restructure its debts. A few creditors, led by a US hedge fund called Elliot Management, refused to accept the deal and sued to try to get fully repaid. A judge ruled that Argentina couldn’t pay only the creditors who accepted the deal without paying the other ones as well. So Argentina paid nobody, putting the country back into default.

While forcing a country to reach an agreement with every single creditor sounds like a far-reaching legal precedent that could make it impossible for countries to ever restructure their debt, in reality it’s now largely irrelevant. Bonds issued by countries now typically include “collective action” clauses that force creditors to accept a restructuring if a vast majority of the other creditors have already accepted it. A collective action clause kicked in when Greece restructured its debt in 2012, for example.

The confluence of events that led to Argentina’s predicament therefore seems like a unique situation rather than a blueprint for what other countries will experience. While defaults are never a positive sign for bond investors, this one is unlikely to have widespread effects.