Episode Details

Argentine Brady bonds carried a spread premium for nine years. The market priced it as compensation for reduced devaluation risk — because the currency board was the explicit institutional commitment that eliminated that risk. The scenario investors did not model was not devaluation. It was the balance sheet consequence of devaluation: eighty billion dollars in dollar-denominated loans to domestic borrowers who earned pesos, a banking system recapitalization requirement that would consume sovereign fiscal capacity before the first bondholder received a cent, and a reserve coverage figure that looked adequate in the headline and was materially smaller in the liquid usable column once Brady collateral pledged at the Federal Reserve was excluded. This episode builds the bondholder's analytical framework from the inputs that were available in the public record by 1999

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: the private sector dollar liability stock relative to usable reserve coverage, the quasi-currency provincial fiscal gap that the consolidated DSA was not capturing, and the Convertibility Law's reserve calculation methodology that counted pledged collateral as qualifying reserves. The practical lesson — applicable to any hard peg regime with private sector balance sheet dollarization today: the convertibility premium compensates for devaluation risk. It does not compensate for the balance sheet consequence of the peg breaking. Those are different instruments with different recovery profiles. The gap between them is what the Argentine bondholders discovered in 2002 at thirty cents on the dollar.