Why hedge funds are holding out on Argentina
This was the second default for Argentina in 13 years. Argentina’s problems began during the Asian financial crisis in 1997. It was also impacted when the dot-com bubble burst in 2000.
The country experienced its worst recession ever in 1998–2002. This time is referred to as the Argentine Great Depression. Economic and political instability in 2001 forced five changes in government in the space of two weeks.
Argentina also experienced capital flight following the Asian crisis. As a result, its reserves position and debt paying ability declined significantly.
Argentina’s default in 2002
In 2002, the country had defaulted on $82 billion worth of sovereign debt. The debt had undergone two rounds of restructuring. The default was more a technical issue because Argentina was denied permission to pay its creditors under the restructuring. It had to pay its “holdout” creditors in full before it could pay its creditors.
Under the restructuring deals in 2005 and 2010, the country paid its creditors only a fraction of what was due. However, some creditors—hedge funds like NML Capital and Aurelius Capital Management—didn’t accept the restructuring. They demanded full payment. Argentina’s current “default” is a result of U.S. District Court Judge Thomas Griesa’s ruling in favor of the hedge funds. Although Argentina has deposited the interest payments on its restructured debt, the court refuses to allow payment unless the dues are paid to the hedge funds.
Market reactions to Argentina’s default
Argentina’s (ARGT) default led to significant shock waves in international financial markets, including the S&P 500 Index (SPY), the NASDAQ-100 (QQQ), and the Dow Jones Industrial Average (DIA). It also led to a 0.52% spike in junk bond (JNK) yields in one week.
The State Street SPDR S&P 500 ETF (SPY) and the SPDR Dow Jones Industrial Average ETF (DIA) were down by 2.64% and 2.71%, respectively, over the week ending August 1. During this week, the actual technical default occurred. The PowerShares QQQ ETF (QQQ) tracks the NASDAQ-100. It was down by 0.37%.
Portugal’s debt crisis
Portugal’s debt crisis was caused by high levels of government spending that the country couldn’t support. Portugal’s central government debt-to-gross domestic product (or GDP) ratio was ~79%. It was high anyway at the start of the financial crisis in 2008. This reflected over 40 years of fiscal mismanagement. Its outsized civil service and the government funded payouts to bureaucrats meant that the country had been steadily increasing its public debt burden over the years. It reached over 126% in 2012. The country was forced to borrow $78 billion from the International Monetary Fund (or IMF) and the European Union (or EU).
In the next section, you’ll read about how interest rate differences across countries can provide significant opportunities for currency speculators.