Argentina Has Started To Go Totally Rogue

Muted headlines about bond swaps aren't doing justice to the announcement Argentina's president made last night.

With her attempt to pass a law nullifying a U.S. Court's ruling that the country pay all its creditors, Argentina is effectively turning its back on the rules governing international finance.

If Argentina's congress passes this law, the country could enter a place where rules no longer matter and negotiation with the hedge funds to which it owes over $1.3 billion in sovereign debt are all but impossible.

What this law does is put debt that was once legally governed by the United States in Argentine jurisdiction.

It's the international markets equivalent of taking your ball and going home.

"So every government can just wave a magic wand and make their problems go away? [If that were the case] everyone would be doing it," said David Fernández, a public finance lawyer at Buchanan, Ingersoll & Rooney. "They're not fixing a problem, they're actually deflecting the issue."

The issue is that Argentina was declared in default for violating a U.S. Court's ruling that said it had to pay all bondholders of its sovereign debt maturing in 2033 together.

A portion of those bondholders - a bunch of hedge fund holdouts known as collectively as NML Capital - had refused to restructure that debt for almost a decade, and for almost a decade Argentina responded to that by refusing to pay NML while others (the exchange bondholders) were paid.

The U.S. Court said that Argentina had to pay the holdouts and the exchange bondholders equally. Essentially - you pay everyone or no one.

On July 30th, Argentina, remaining steadfast in its refusal to pay the holdout "vulture" hedge funds, chose the "no one" option.

Of course, making that choice doesn't mean Argentina wants to deal with the consequences. The purpose of this law is to avoid paying the holdouts while still being able to argue that the country is not in default, as the body governing such decisions, the International Swaps and Derivatives Association, declared.

So here's how Argentina wants to do it. It's going to change the jurisdiction of these bonds from the United States to Argentina, and then change the custodial bank from Bank of New York Mellon to Argentina's Banco Nacion Trust.

That way, it won't have to deal with any pesky American laws. And as the country's Economy Minister, Axel Kicllof said in a speech today, if any investor wants to get paid, they can go to Argentina and get the money under Argentina's rules.

Now, this plan should sound familiar because it was outlined in a memo from Cleary Gottlieb Steen & Hamilton, Argentina's attorneys, to The Republic back in May. At that time, of course, attorney Carmine Boccuzzi said Argentina would never do such a thing.

"There is no secret plan to evade," he said.

So will it work? Can a country just snap its fingers and dissolve a contract? Can it just fire its custodial bank while it's technically in default?

Fernandez says: Not really. Or at least, it's very messy.

"They're literally playing with fire," said Fernandez. "The fact of the matter is, where's the money? It's in the U.S., under our jurisdiction ... This will turn into a high profile situation between the U.S. and Argentine governments."

And who wants that? Certainly not the market, and at the end of the day it is the market that will determine how affective this tactic is. Its verdict to investors is 'get the heck out of Dodge' - Argentine bonds are already falling on the news.

"The execution risk [of this new law] should be high and initial participation quite low as real money investors are discouraged from participating at risk of violating the pari passu judgment," said a note released by investment bank Jefferies.

We'll know more about how much investors trust Argentina on September 2nd, when the International Swaps and Derivitives Association will hold an auction for some of Argentina's defaulted debt. The original date for the auction was August 21st, but this new development is throwing things for a loop.

Worse for Argentina, it's making the holdouts sound like they were right in saying that the government never intended to pay them this entire time. Argentina had been playing the victim, but this law will likely be seen as an incredibly aggressive act in the eyes of the international community.

The way President Fernandez told it last night, though, she is simply guarding one of the greatest economic miracles of our time - her country's recovery from its 2001 default.

"I really feel that we're living through a moment of real injustice being done to The Republic of Argentina," she said. "And I believe that a new world order [supports us], because we've been supported the world over, since the organization of bodies like MERCOSUR, like CELAC, like UNASUR, like 100 academics have presented to the U.S. Congress, like... many articles have said all over the world, for simple logic we are being supported. But they are not supporting a government, they are supporting the end of something so crazy that it wants to topple the most successful debt restructuring in recent memory. And it's not only the most successful because it happened, but because it happened during a time of social inclusion for all Argentines. This is missing in many parts of the world in a similar situation."

Now, thanks to this law, there is no similar situation. Never has been.