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Argentina is cautionary tale as U.S. debates debt limit

Creditors are trying to seize the property of Argentina, which defaulted on its bonds in 2001. Could the same thing happen to the U.S.?

Michael Hiltzik

7:20 PM EST, January 15, 2013

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You know all those warnings about how America's addiction to deficit spending is going to make us look like Greece?

Stop worrying. The bigger concern should be that America will look like Argentina.

That could happen, theoretically, if the threatened refusal by Republicans in the House to raise the federal debt limit leads to a default on U.S. government bonds. How bad would it be, you ask?

Think about this: Because of lawsuits over Argentina's 2001 default on nearly $100 billion in sovereign debt, President Cristina Fernandez de Kirchner rents a private jet for state visits abroad. That's because she fears that her presidential plane (dubbed "Tango 01") would be seized by creditors the moment it landed at a foreign airport.

In October, the creditors came this close to grabbing an Argentine naval frigate, the Libertad, when it put in at port in Ghana with 220 crew aboard. Ghana detained the training vessel for about two months, until an international court ruled that, as a military asset, it was immune from seizure.

QUIZ: Test your knowledge about the debt limit

The creditors, which include Elliott Management, a hedge fund that also has been a big investor in Hollywood, have also taken steps to go after personal assets of Fernandez and members of her Cabinet. They've succeeded in freezing Argentine central bank assets in the U.S., and in 2009 even tried to attach a dozen Argentine dinosaur fossils on exhibit in Germany.

In short, it's a mess.

Now think of the United States in a similar situation. President Obama can't fly Air Force One to a summit meeting for fear that a bill collector will take the keys. The carrier Enterprise gets detained at Okinawa. The family car of a low-level consular official gets pulled over and impounded in Beijing. The Obamas' checking account gets attached by a hedge fund.

This may sound far-fetched, and the international debt experts I've consulted say it is far-fetched. But the U.S. government itself has said that some U.S. court rulings against Argentina — such as those allowing creditors to seize Argentine property here — could backfire against the U.S. The State Department and Treasury said in a brief last April that they're concerned that the rulings could encourage foreign courts to "issue like orders against the United States and its property abroad." That would undermine the principle of sovereign immunity that protects U.S. diplomatic personnel, embassies and military assets overseas.

Experts in international finance say a U.S. bond default, even if "technical" and even if it lasts a day, puts us in uncharted territory. After all, Argentina also thought all the existing consequences of its post-default settlement were far-fetched. Its settlement, which involved trading its defaulted bonds for new ones on which it has kept up payments, was drawn from the standard textbooks on Third World default settlements.

Owners of 93% of the defaulted bonds traded them in for the new issues at about 30 cents on the dollar, so the Argentines thought they were free and clear. They didn't reckon with the tenacity of the holdout "vulture funds" that now own the other 7% and have created the subsequent dolores de cabeza.

These days, headaches are almost a statutory feature of U.S. government debt, thanks to the game of brinkmanship being played by the House GOP over the federal debt limit.

It's proper to remember that the debt limit, which was enacted in 1917 to make the issuance of Treasury bonds easier, not more fraught, has nothing to do with how much money the government spends. Rather, it's about how to pay for programs that Congress (including Republicans) already has enacted, but for which it hasn't made sufficient provisions to fund via taxation. For Congress to set fiscal demands requiring borrowing and then to prohibit that borrowing as a tool of "fiscal responsibility" could make sense only to people still playing with their toes in the crib. But when your government is held hostage by infants, these things happen.

Technically speaking, the government has already breached the debt limit, but the U.S. Treasury's ability to move accounts around has staved off an actual breach for a few weeks or so. If Congress fails to act by then, the consequences for the U.S. economy and global financial markets could be dire. Interest rates could spike, the recession could return, the federal deficit could soar. That's just for starters.

"It's a pretty dangerous game to be playing," says Stephen J. Lubben, a debt expert at Seton Hall Law School in New Jersey. "So much of the financial system depends on U.S. government debt being risk-free that if you call that into question, there's a domino effect that could happen to all kinds of other assets."

That's why ideas to circumvent the intransigence of the House Republicans and stave off default have such a desperate, rococo flavor: Minting a $1-trillion platinum coin and depositing it at the Federal Reserve; invoking the 14th Amendment, which supposedly makes debt service on Treasury bonds sacrosanct; issuing federal IOUs to employees and contractors; paying only bond interest and principal and stiffing Social Security recipients — the list goes on and on.

But the Treasury and the Fed both have put the kibosh on the coin idea, the White House has said it won't invoke the 14th Amendment, it's not clear if the government can issue IOUs and legal experts differ on whether the government can prioritize one financial obligation (to T-bond holders) over another (to retirees). The only valid way out is for congressional hard-liners to grow up already, and for the debt limit law to be repealed so that the world economy can't be threatened any longer by extremist nudniks.

In the meantime, there are the lessons of Argentina. The country's debt restructuring points to how much can go wrong when you're in uncharted territory. The holdout bondholders, some of which bought the deeply discounted securities in the hopes of making a killing in court, have benefited from the rulings of U.S. District Judge Thomas Griesa in New York.

Griesa has interpreted a complicated clause in the Argentine debt contract as requiring the holdouts to be paid off in full, even though those who exchanged their old bonds for new will get only pennies on the dollar. The holdouts claim that they're owed about $1.6 billion, which Argentina has thus far refused to fork over. An appellate court hearing on the matter is scheduled for late next month.

Most experts think the case is more important for debt restructurings by nations other than the U.S. That's because, unlike debt issued by countries like Argentina, U.S. Treasury bonds merely promise payment but don't spell out what bondholders are entitled to in case of a default, if anything. That's the privilege that comes with being a "high-quality sovereign borrower," Lubben told me.

But what if a default makes the U.S. not such a high-quality borrower? Who knows?

It may be hard to find U.S. government assets abroad that aren't specifically protected against seizure by treaty, as is diplomatic and military property. "I suppose [bondholders] can try and seize an aircraft carrier," says Steven M. Davidoff of Ohio State University, who writes extensively on financial deals. "Good luck with that."

Moreover, there may be government assets abroad that don't fit into those categories — for example, the U.S. is still a 19% owner of General Motors, which has plenty of property overseas. And there's always a chance that some aggrieved bondholder, like the Chinese government, might decide to pick a fight with the U.S. by testing the limits of sovereignty in a default. Would the U.S. invariably win? Who knows?

International political and economic relations are flammable enough to not throw additional, and entirely unnecessary, kindling on the fire, as Argentina has already learned. The people in Congress who think it's no big deal to see how high the flames might go should be called by the right label. They're arsonists.

Michael Hiltzik's column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.