Argentina Default: Is Paul Singer Playing Both Sides?

By Bianca Fernet

Life is rarely win-win.

Unless you count the rare cases where you can insure against something terrible happening, position yourself to profit greatly from the terrible thing taking place, and then take action to force the terrible thing to occur unless an alternative, equally or more profitable scenario takes place.

Kind of like if I could sign a contract with the fire department to deliver US $1.5 billion to my house if it does NOT burn to the ground next week, buy a fire insurance policy for US $20 million, then douse my house in gasoline and laugh while the firemen face the decision to either save my house and go bankrupt, or allow it to burn to the ground and watch me collect on the insurance policy.

But Bianca!“, you must be thinking, “That sounds like an absurd combination of insurance fraud and arson that would surely put someone in prison!

And in the case of nearly everything except the hot, sexy, dangerous world of international finance you’d be correct. So put on your sexy fire-person costume and let’s dive in.

Is it possible that the vulture funds are pushing Argentina into technical default to trigger payments on credit default swaps (CDS)?

In order to avoid default, Argentina will most likely have to pay holders of non-exchanged debt, primarily the so-called “vulture funds,” upwards of US $1.5 billion.

If Argentina defaults, banks like JP Morgan and Citibank that have issued CDS contracts, or insurance against Argentine default, will have to pay holders of these financial instruments a lump sum equal to the face value of the bonds plus outstanding interest payments for each one of the 2915 outstanding CDS contracts. CDS have only been issued on the restructured bonds.

If the vulture funds hold CDS contracts, they will receive a payout, albeit a much smaller one, in the event of an Argentine default, and still remain holders of the unrestructured debt and thus be able to continue litigating for full or partial payment on these debt securities. In the context of the house on fire example, I would collect on the insurance and the fire department would STILL have to pay me the US $1.5 billion or a portion thereof at some point in the future to prevent me from seizing their fire trucks or to be blocking their access to things like bank accounts or a credit cards (locking them out of financial markets).

A similar situation is said to have occurred in Malaysia in 1997 between the Malaysian government and the very clever George Soros. While the illustrious Mr. Soros is frequently vilified for betting against emerging market currencies during the East Asian financial crisis, his most delightfully devilish dance with money occurred when Malaysian prime minister Mahathir Mohamed defended its currency, the ringgit, against pressure to devalue vis-a-vis the US dollar.

In order to keep money from fleeing Malaysia faster than Cal Hockley from the Titanic and to keep the currency from tanking like, well, the Titanic, Malaysia enacted laws known as capital controls that restricted the outflows while simultaneously hiking interest rates. The undesirable consequence was a drop in the Malaysian stock market – typically when a government raises interest rates, the stock market falls because investors can get better returns by keeping the money in bonds or the bank and earning that high interest rate.

So what did Soros allegedly do? Short the ringgit by entering into transactions whereby he made money if the value of the ringgit fell, while simultaneously shorting the stock market by entering into contracts whereby he made money if the value of the stock market fell. He then used his massive holdings of the Malaysian currency as well as his international renown and influence to sell the currency and publicly express his opinion that the currency was doomed, encouraging investors to follow suit. Ta da! A double play. Mr. Soros made money in the stock market every time the Malaysian government intervened to defend the ringgit, and could keep up the pressure until the ringgit collapsed and triggered the big payout.

As international finance lore holds, what Mr. Soros did not foresee was the Chinese government stepping up to the plate (cricket wicket?) and abruptly changing the rules of the game. At the same time that Malaysia hiked rates and instituted controls, China essentially bought the stock market – interest rates increased and stock value increased. This broke the double play situation that Soros was enjoying by changing the game and ruining his win-win position.

Is what Mr. Soros pulled off nice? No. Was it illegal? Also no. Could the Singer be pulling a George Soros and have created a win-win situation whereby he comes out on top whether Argentina defaults or not? Possibly.

The CDS contracts and Argentine bonds are not legally linked; for example, I can hold CDS contracts without owning an Argentine bond and it will function like a bet that Argentina will default. Furthermore, while we know there are close to 3000 CDS contracts out there on the market, we do not know who owns them.

The International Swaps and Derivatives Association (ISDA) is responsible for deciding whether or not a default has occurred, triggering a “credit event,” or payout to CDS holders. The legal aspects of this decision are as complex as the vultures vs. Argentina case itself – for more details check out this fun legal brief.

There are three broad divisions of possible outcomes, and in each case there are pretty clear winners and losers:

Outcome #1

Argentina pays holdouts US $1.5 billion to avoid default. The “vultures” win, and holders of restructured debt potentially stand to gain by receiving more funds as well. Argentina loses.

Outcome #2

Argentina makes no payments and is declared to be in default. The holders of CDS contracts receive a payout, holders of restructured debt face uncertainty but still hold the debt that will likely be paid at some time, and the “vultures” can continue legally battling to receive payment. Argentina suffers the consequences described in The Bubble’s own countdown to default column.

If the “vultures” hold CDS contracts, this is not a bad situation to be in.

Outcome #3

Argentina reaches an agreement with a combination of Griesa or the holdouts to neither make full payment nor to be declared in default. This is the only situation in which Argentina wins (kind of).


It is likely that the vultures hold CDS contracts, but difficult to quantify if this payout is significant, or would come close to offsetting their legal/operating fees to date. The CDS payout would not come close to the payday expected if Argentina is forced to pay the full amount owed on the non-exchanged bonds. Nevertheless, it is possible the CDS market allows the vultures to sit pretty in a relatively risk free environment, biding their time and pushing for full payment or a higher payout than the 70% haircut given to exchange bondholders.

There are individuals in the Argentine media who are making the same claim, but as I said before, the data on who holds the CDS contracts and thus stands to gain in the event of a technical default is not easily obtainable. Furthermore, Paul Singer is a member of the ISDA, adding another element of fun to the conspiracy theory camp.

So is Paul Singer executing a double play against Argentina? It’s a possibility. But like Soros in East Asia, if he is, he is merely playing with the legal aspects of the cracks that exist in the economy.

Now if you excuse me, I have some gasoline to buy and matches to steal…By Bianca Fernet

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