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By Ronald Fink
A bill introduced in Congress aimed at limiting distressed debt investors' ability to profit from developing countries' woes threatens to damage an already fragile bond market, critics warn.
The legislation, introduced in the House last August by Rep. Maxine Waters (D-Calif.), would make claims on bonds of "protected countries" that trade at a discount from their face value unenforceable in court. Waters' bill would bar any lawsuit that demanded more than the amount an investor paid to buy such debt plus 6 percent interest per year.
Reuters columnist Felix Salmon reported last Friday that Sen. Russell Feingold (D-Wis.) is considering sponsoring a companion bill and warned that such a move could damage the capital markets. "Debt markets would react very badly to any attempt to prevent or impede trading debt instruments in the secondary market," the columnist wrote.
Stephen Lubbens, a Seton Hall University law professor, went further in a post on the website, Credit Slips, the same day, noting that he sees no way courts could limit the ban to sovereign debt. And that, he says, could threaten all sorts of bonds.
"Does this mean that whenever bond debt trades at below face value it implicitly trades without enforcement rights?" Lubbens wrote. "That will do wonders for the high-yield market."
He and others observe that such a proposal flies in the face of a legal principle established during the U.S. Revolutionary War. At that time, Alexander Hamilton fiercely and successfully defended the proposition that the debt owed to Continental soldiers -- bought at pennies on the dollar by speculators -- had to be honored at face value out of fear that the new nation's credit would otherwise be damaged.
Because of that, some observers doubt the measure will gain traction.
"Putting in a law that allowed claims on U.S. corporate securities only at the purchase price would be a radical step that I have a hard time believing would happen," Martin Fridson, a high-yield bond analyst who runs a New York City investment advisory firm, wrote in an email to CFOZone on Wednesday.
"At least not without a fight on the scale of the present health care debate," he added.
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