Monday, October 6, 2014

IMF Reacts to Argentina Debt Default with Reform Proposals

We have followed the debt default situation in Argentina on this blog. We noted that while this seems to be just a problem for Argentina, much more is at stake. We noted that all the major global financial institutions were following that case and expressing concerns about it setting a precedent in other sovereign debt problem nations.

Tonight the IMF releases a new report stating that the IMF Executive Board is supporting some major reforms to sovereign bond contracts to try and avoid the problems now in progress in Argentina. Here is a link to the article.

Below is an interesting Q&A from this article which we will follow with a comment.

"IMF Survey: Isn't there an outstanding stock of bonds that will not be affected by these reforms? Don't they still pose a risk to the system? And what can the Fund do about them?

As the paper highlights, there is a significant volume of outstanding stock that does not contain the new clauses, and which will not mature for some time. We have explored whether or not sovereign issuers and market participants would be willing to accelerate the turnover of the existing stock through liability management exercises—essentially exchanging their existing bonds for new bonds that don’t have these problematic provisions. Right now, the appetite for liability management is somewhat limited, but that may change if, in fact, the Argentine litigation begins to have a broader impact on the system.
We will continue to monitor this situation both in terms of the dangers presented with respect to the outstanding stock and in light of additional steps that may need to be taken."
My added comment: One of the main objectives of this blog is to try and reach out to the average person (like myself) and encourage him or her to take these issues and potential problems seriously. 
This new IMF article once again illustrates that we are not alone is identifying the very high sovereign debt ratios around the world as one of these problems to take seriously. The IMF says point blank in this article there is a threat from this debt to the system. They are taking it quite seriously. They are proposing major contract changes to try and avoid a messy legal battle when sovereign debt does go bad.
They again express concern that the situation in Argentina could have "a broader impact on the system."  They state that there are a lot of bonds sitting out there around the world that do not have this proposed contract language in them and that "right now, the appetite for liability management is somewhat limited."
They also note in the article that they have no power to enforce these bond contract changes, but are hoping their support for them will influence those writing the bond contracts. All they can do right now  is "monitor the situation."
While reading this article please keep in mind that all this sovereign debt that the IMF is concerned about also has trillions and trillions of interest rate related derivatives tied to it. Supposedly all these trillions and trillions of interest rate derivatives are somehow hedged against each other. But no one really knows for sure if that is true or not. Many derivative contracts are not transparent to the public so only the parties involved in them know the true risks involved. And if one counterparty cannot pay, it can set off a chain reaction in the system.
What that means is that if there is a major sovereign debt crisis or default anywhere in the world, it could trigger a chain reaction in related derivatives contracts reaching into the trillions of dollars. Now we see both why the IMF is concerned about this topic and why the average person should be too. 

Update 10-7-14: Today the IMF once again announces that global GDP will fall short of their earlier forecast and that deflation is still a big concern.

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