65 Words Just Caused Argentina's $29-Billion Default

A tale of debt and difficult English

Paulo Santos/Reuters

At the stroke of midnight last night, Argentina officially defaulted on $29 billion worth of debt. It was the eighth time in its history, and the second time in 13 years, that Argentina told its foreign creditors it would not pay its bills.

But this time was different, and rather bizarre. When Argentina last defaulted, in 2001, it had roughly $80 billion worth of debt it couldn’t pay back. It was, at the time, the biggest sovereign-debt default ever. This time, Argentina—Latin America's third- or fourth-largest economy, depending on who you're asking—had the money on hand to pay a $539-million bill due by close of business on Wednesday. It didn’t make the payment, and as a result has now technically defaulted on the entire $29 billion it owes international creditors. All this, in turn, is the result of how an 83-year-old judge interpreted the following 65 words:

The Securities [i.e., the bonds] will constitute . . . direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu and without any preference among themselves. The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness (as defined in this Agreement).

The above, in the words of the Financial Times’  Joseph Cotterill, is “a piece of dusty boilerplate,” more than a century old and ubiquitous in sovereign-debt agreements. Legal analysts sometimes refer to it as an “equal-treatment” clause, because it suggests that a borrower has to treat all its lenders equally—if I borrow money from Jane and Jack, I can’t choose to pay back Jane and not Jack.

That’s what the clause suggests, anyway. But no one seems to know for sure what it actually means. As Benjamin Chabot of the Chicago Fed and Mitu Gulati of Duke Law School wrote in a history of what's also called the "pari passu" clause, it appears frequently but is seldom even read. "It is there because it's always been there," one lawyer told them. "No one really thinks about it."

The story of how this inert slab of legalese caused a global financial incident stretches back 13 years, to Argentina’s last default, and centers on an unlikely villain (at least in the eyes of Argentines): an elderly Manhattan magistrate from Kansas City who plays the harpsichord and likes cookies with lunch.

After Argentina’s 2001 default, the country struck a deal with its creditors, offering to pay them some but not all of what it owed them. It has been paying back most of its creditors under this arrangement ever since. But a small number of hedge funds—Argentina calls them “vulture funds”—declined to accept the reduced payments and sued instead, demanding to be paid in full. They’ve been pressing that demand in the courts for more than a decade.

And here’s where those 65 words come in. The vulture funds’ move essentially created two different kinds of creditors for Argentina: those who accepted the deal, whom Argentina continued to pay, and the holdouts who didn’t, whom Argentina stopped paying. In February 2012, U.S. District Judge Thomas Griesa ruled that Argentina couldn’t pay the first set of creditors without also paying the holdouts, since treating them differently would violate the equal-treatment clause. Years of appeals, injunctions, and stays on injunctions finally ended on Wednesday when Argentina missed a July 30 deadline to pay interest on the part of its debt it was still repaying. Griesa’s order had made it illegal for Argentina to pay that bill without also paying the holdouts.

Why was a U.S. judge in a position to say what Argentina should do with its money to begin with? Because Argentina submitted to U.S. jurisdiction over some of its bonds back in the 1990s. But Judge Griesa's ruling was unprecedented. The pari passu clause, writes Cotterill, "has been used against sovereigns before, but never in the U.S., nor with such wide sweep."

Negotiators including Argentine Economy Minister Axel Kicillof scrambled this week to find a way out of the legal impasse as the payment came due; they kept negotiating even after the Standard & Poor's rating agency declared that Argentina had defaulted because, technically, markets were already closed in Asia, meaning Argentina had missed its deadline to pay creditors there. Others interpreted the July 30 deadline to mean Argentina had until midnight Eastern Standard Time to avoid default. Regardless, by the time Kicillof held a press conference on Wednesday afternoon announcing that negotiations had collapsed, it was clear Argentina wouldn't be paying up on time.

That doesn't preclude additional negotiations, though. As of Thursday morning, The Wall Street Journal's headline writers still held out hope that Argentina was only teetering "on the brink" of default. And the outlook for tomorrow is even foggier than the history of yesterday. As Bloomberg's Matt Levine wrote on Wednesday:

Of course, nothing particularly happens on a default. I mean, if you own Argentine exchange bonds, you didn't get paid yesterday, and you didn't get paid today, and tomorrow isn't looking great exactly, though it is looking up. And if you're Argentina, you didn't have great access to international capital markets yesterday, etc. etc. The difference between 'default' and 'unpleasant but not technically default' is, you know, pretty technical. ... If Argentina defaults today, settles with its holdouts tomorrow, and pays its exchange bondholders on Friday, everyone will be pretty happy.

There is one clear lesson, though: Always read the contract.