In June, the US Supreme Court ruled that Argentina Cannot Selectively Default on a small group of hold-outs demanding full payment on otherwise restructured government bonds.

The problem with the ruling is that if Argentina pays the vulture fund full value, it will have to pay all the bondholders full value, and that would wreck the country again.

In the future, bond agreements will force everyone to go along with a majority decision.

In the meantime, US courts ruled Argentina must negotiate will all the parties, including the vulture funds that own roughly 8% of Argentine debt and demand full payment on it.

The ruling meant, and banks enforced, the all or none principle. Argentina defaulted on all the bonds, not because it wanted to, but because US courts forced that outcome.

Local-Law Swap

In an attempt to circumvent the ruling, Argentina will swap the bonds in question for new bonds. It will then hope to pay the 92% according to the prior workout agreement, leaving the vulture funds in limbo.

With that backdrop it will be easier to understand today’s Bloomberg report Argentina’s Bonds Decline on Plan to Offer Local-Law Swap.

Argentina’s bonds sank to a two-month low after the government said it plans to pay foreign-currency notes locally to sidestep a U.S. court ruling that blocked payments and caused its second default in 13 years.

The government will submit a bill to Congress that lets overseas debt holders swap into new dollar-denominated bonds governed by domestic law, President Cristina Fernandez de Kirchner said in a nationwide address yesterday. Payments will be made into accounts at the central bank instead of through Bank of New York Mellon Corp., the current trustee.

Fernandez’s move flies in the face of orders from U.S. District Judge Thomas Griesa that a swap would be illegal. He has said the nation must pay $1.5 billion to holders of debt defaulted on in 2001 or reach a settlement before resuming payments on restructured notes.

The country’s benchmark restructured bonds due in 2033 fell 2.58 cents to 80.16 cents on the dollar as of 11:47 a.m. in New York, the lowest level since June 19. The price is still above the 74.03-cent average of the past five years.

On June 20, Griesa said that Argentina is prohibited from paying the overseas bonds in Argentina under a local law. Any intermediaries assisting Argentina in the process could be sued for contempt of court, while investors who aren’t able to hold local bonds would have to sell their holdings.

The Argentine president has argued that obeying the ruling by paying the holdouts would trigger a Rights Upon Future Offers clause in the exchange bond contracts that obliges Argentina to match any improved offer to all bondholders. That could trigger claims of at least $120 billion, according to the proposal.

Intermediaries Now Gone

The trustee and primary intermediary was Bank of New York Mellon Corp. Kiss that intermediary goodbye. Bondholders can get payment directly from Argentina’s central bank.

The fact that debt is above average valuation of the past five years looks promising. The article suggests Argentina will be shut out of the credit markets.

Is that necessarily the case?

After all, Argentina is going out of its way to pay 92% of the bondholders who agreed on the initial restructuring.

Nonetheless, Bloomberg reports “U.S.-based investors may be wary of taking part in the swap over concern they will be held in contempt of court, according to Casey Reckman, an economist at Credit Suisse.

If so, it’s ridiculous. In fact, the Supreme Court ruling is ridiculous. When you make risky bets, some of them work, some of them don’t.

The idea that bondholders or even certain bondholders can never take losses is idiotic, yet that is what the court ruled.

Argentinian Peso in Massive Slide

Inquiring minds may be interested in how the Argentinian Peso has been holding up under the circumstances.

Peso vs. US Dollar

Since late 2007, the peso has fallen from 3.02 to the dollar to 8.32 to the dollar. That’s a decline of 63.7%.  

Question of Reserves

Argentina has about $29 billion in foreign currency reserves. Is that enough?

The Wall Street Journal discussed the issue the other day in Argentine Bonds Fall Further as Talks Stall.

Investors are more focused than ever on Argentina’s reserves, which the central bank uses to defend its currency and fund imported goods.

Unable to borrow hard currency abroad because of a debt dispute in U.S. courts, President Cristina Kirchner has instead borrowed $31 billion from the central bank to pay public- and private-sector creditors since 2010.

Reserves stood at just under $29 billion on Thursday, up about $2 billion since the end of March thanks to exports of a record soy harvest and import restrictions.

Payments to multilaterals this year won’t necessarily mean a net decline in reserves because Argentina frequently gets new loans as it pays back those lenders.

Even so, Argentina’s reserves are among the lowest of major Latin American economies due to government borrowings and capital flight by investors weary of Mrs. Kirchner’s populist policies.

Inflation thought by many to be around 40%, dollar shortages that have forced the government to restrict vital imports, and sluggish trade with neighboring Brazil pushed Argentina into recession earlier this year. The economy is expected to contract about 0.9% in 2014, according to the latest monthly survey of analysts by FocusEconomics.

Argentina defaulted on some of its bonds on July 30, after it missed a roughly $539 million interest payment due to its restructured bondholders. U.S. District Judge Thomas Griesa has ruled that Argentina can’t pay its restructured bondholders until it pays the holdouts, which are a group of hedge funds suing the country for full payment on bonds it defaulted on in 2001.

Argentina has argued that it isn’t in default because it deposited on June 26 with Bank of New York Mellon BK +0.36% the money necessary for the interest payment. The deposit was made in both dollars and euros. However, BNY Mellon hasn’t passed the money along to bondholders because Judge Griesa also warned that any bank who helps Argentina process the payment would be violating a U.S. court order.

Judge Griesa reiterated in an Aug. 6 order that BNY Mellon will keep the money in its account until otherwise ordered by the court. He also said BNY Mellon wouldn’t be held liable for claims by bondholders.

On Friday, a group of restructured bondholders who own Argentine bonds denominated in euros appealed Judge Griesa’s Aug. 6 order to the U.S. Court of Appeals for the Second Circuit. The euro bonds were among the ones Argentina defaulted on two weeks ago because BNY Mellon wasn’t allowed to process the interest payment Argentina deposited. These bondholders have tried to get their interest payment by suing BNY Mellon in Belgian courts, and they have threatened to sue the bank in U.K. courts.

As noted above, US courts ruled the holdouts must be paid in full, or nobody paid at all.

Yet, if Argentina paid the holdouts, it would trigger $120 billion in other claims, and Argentina only has $29 billion in reserves.

Inane US court ruling? I think so.

Mike “Mish” Shedlock