Last Tango in Buenos Aires

There’s a legal adage that goes, “Hard cases make bad law.” A recent U.S. court ruling against Argentina, which pushed the country into a new technical default on its sovereign debt, is a case in point. In 2001, Argentina defaulted on $80 billion worth of sovereign debt, the bonds that a country issues to raise money. It had to restructure, just as Greece had to more recently, and over the years, some 93% of creditors went along with the cut-rate deals, taking “exchange” bonds that paid 30¢ on the dollar. But some, like Elliott Management, the hedge fund started by Wall Street titan Paul Singer, held out. Tens of millions of dollars in legal fees later, Elliott won its case.

U.S. federal judge Thomas Griesa ruled earlier this summer that unless Argentina paid creditors like Elliott and other holdouts 100% of their claims, it couldn’t pay anybody else either. Paying Elliott in full would mean that, contractually, the country would also have to pay everyone else in full too–a $29 billion commitment. The case is full of gnarly legal and financial issues. But what it tells us is dead simple: the world financial order is still far too complex and opaque.

It’s tough to cry for Argentina–or the hedge funds. Elliott says Argentina’s claim that it has been victimized by “vulture funds” is a populist political strategy to drum up support for President Cristina Fernández de Kirchner’s flagging party. “Argentina isn’t a poor country. It’s a G-20 nation,” says Jay Newman, Elliott’s Argentina-portfolio manager. “It’s chosen for political reasons not to negotiate a fair settlement with us or more than 61,000 other bondholders.” Certainly no one would argue that the Argentine government is a paragon of best practices; Argentina, which had the same per capita GDP as Switzerland in the 1950s, has defaulted eight times.

Then again, the vultures haven’t done so badly either. Many bought bonds postdefault for pennies on the dollar. Now they are eschewing an already rich return for a regal one, while setting a precedent that could make creditors reluctant to cooperate when nations default in the future. “This has become a morality play which has given rise to a host of new legal problems,” says Jonathan Blackman, the Cleary Gottlieb partner defending Argentina. Both sides are waging an ugly media war complete with ad campaigns, as thousands of other creditors and financial institutions around the world nervously await the final result.

The Argentine crisis says three important things about the global economy. First, the balance between creditors and debtors has shifted. As data from the McKinsey Global Institute (MGI) show, there’s more debt globally than there was before the 2008 financial crisis. But now, the largest portion of it consists of public-sector debt. “Debt in the economy is like a balloon,” explains Susan Lund, a partner at MGI. “When you squeeze it out of one place, it grows in another.” With the rise in public debt comes a greater risk of sovereign defaults, which can wreak havoc on the global economy. (Remember the euro crisis?)

Second, the global economy is becoming more fragmented. The fact that a federal court in New York City ruled in favor of the holdouts is a sign that the global economy is splitting along national and ideological lines: British courts tend to go with majority rule in sovereign cases, and local markets have any number of other ways of handling sovereign-debt deals. The BRIC nations, aside from increasingly cutting their own trade deals, have set up a new development bank, which may become a source of capital for countries like Argentina if they remain shut out of the Western credit markets. That could give Russia and China more leverage over, for example, Argentina’s natural resources. (The country has the world’s second largest shale-gas deposit.)

Finally, the case shows how much work remains to be done in making our financial system more transparent. In addition to establishing a single standard for sovereign default, we desperately need to make complex security holdings more visible. Academics like Joseph Stiglitz say Elliott Management actually stands to benefit from an Argentine default, since nearly $1 billion worth of credit-default swaps exist on the country; that’s insurance that will pay out now that Argentina has defaulted. While the Elliott subsidiary that went to court against Buenos Aires says it holds no such swaps, the hedge-fund firm as a whole doesn’t disclose trading positions, and the swaps holdings of individual companies aren’t public record. They should be. Knowing exactly who stands to gain–or lose–from fiscal turmoil that can affect all of us could help make the right fixes at least a little more apparent.

TO READ MORE BY RANA FOROOHAR, GO TO time.com/foroohar