tag:theconversation.com,2011:/uk/topics/vulture-funds-11263/articlesVulture funds – The Conversation2014-09-01T20:26:27Ztag:theconversation.com,2011:article/311202014-09-01T20:26:27Z2014-09-01T20:26:27ZBid to avoid repeat of Argentina debt row risks a sting in the tail<p>Sovereign debt is a crucial lubricant for growth, especially among emerging nations, and so it is equally crucial that we can ensure the <a href="https://theconversation.com/why-argentina-matters-for-indebted-countries-everywhere-30801">interminable row over Argentina’s default</a> is not repeated. Measures proposed to do just that, however, might just make things worse.</p>
<p>Argentina’s latest default (its eighth) has at least sparked key players into action. According to <a href="http://www.ft.com/intl/cms/s/8e27f6b8-2e8b-11e4-afe4-00144feabdc0,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F8e27f6b8-2e8b-11e4-afe4-00144feabdc0.html%3Fsiteedition%3Dintl&siteedition=intl&_i_referer=http%3A%2F%2Fwww.ft.com%2Fhome%2Fasia#axzz3Bk1HkvYl">a report in the Financial Times</a>, the International Capital Market Association (ICMA), whose members include banks, investors and debt issuers, has created fresh clauses for inclusion in sovereign debt contracts that will give countries the option to bind all investors to decisions agreed by the majority.</p>
<p>It is an effort to keep the wheels turning smoothly in international financing: Just as a new company requires loans to start up, emerging markets must depend on richer countries to fund their development needs. </p>
<p>But, just as a company may go bankrupt because of external factors, a country may be faced with economic crises that make it difficult to repay the debt. A company in that situation can declare bankruptcy and reach a deal with creditors to restructure or sell assets in a deal brokered by the local courts. When the same situation faces an entire nation, there is no international court that can enforce contracts between creditors and debtors from different countries. This lack of enforceability creates a host of problems.</p>
<h2>Credit where credit’s due</h2>
<p>A natural question is that if creditors are aware of the non-enforceability of contracts, why would they lend in the first place? And how can sovereign states then raise funds? The obvious answer is reputation for repayment. If a country shows that it is credit-worthy because it repaid loans in the past, then this reputational capital may be used to attract funding. In principle, a better credit history may imply better terms of repayment – and we can all relate to that.</p>
<p>However, this relies on the creditors being able to punish the debtor country effectively once default occurs. In other words, if there is no punishment after default, then the signal is that debt will be forgiven in any case and may lead to less effort to repay on the part of the debtor country. This undermines the reputation mechanism and is a particularly salient issue when there are multiple creditors, as in the case of most sovereign debt, and notably Argentina. </p>
<p>Argentina’s experience has acted as a pretty thorough examination of the flaws in the current system. In 2005, at the time of the last crisis, the country had agreed on reduced debt servicing with the vast majority of creditors (75% of the defaulted bonds). In 2010, another 17% of the original bond holders agreed to the new terms. Thus all but a small minority of the bondholders agreed to a proposed “haircut” on their debt which essentially meant creditors sacrificed 35% of what they were owed.</p>
<h2>Out for blood</h2>
<p>The 8% of bondholders who did not accept the terms, <a href="http://www.businessweek.com/articles/2014-08-07/argentinas-vulture-paul-singer-is-wall-street-freedom-fighter">“vulture” investors like Elliott Associates</a>, specialise in buying up cheap debt and seeking full repayment when the country comes out of the crisis. They sued the Argentinian government for full repayment plus the interest accrued (about $1.5 billion). Had the debt been issued in Argentina, it would be handled by judges within Argentina. The problem was that the debt was issued in New York and thus subject to the American judicial system (this made it cheaper for Argentina to borrow money). </p>
<p>Judge Greisa, the governing judge in the case, <a href="https://theconversation.com/argentinas-vulture-defeat-shows-courts-have-too-much-power-28623">has ruled in favour of the vulture funds</a> and has prevented Argentina from paying back the restructured debt to other creditors until it pays the full amount asked for by Elliot Associates. This has virtually sent Argentina into an involuntary default. </p>
<p>So, what’s going to happen now? What can Argentina do? <a href="http://www.bloomberg.com/news/2014-07-30/argentina-defaults-according-to-s-p-as-debt-meetings-continue.html">Standard and Poor’s has already downgraded Argentinian debt</a>. Usually, as after the Greek crisis, a downgrade means that countries can only borrow at very high rates of interest. In the case of Argentina, this may not happen because investors realise the reason for the default is not in Argentina’s control. If Argentina were to do what Judge Greisa has ordered, it opens itself up to a spate of legislation from other creditors, making another default inevitable.</p>
<p>The main problem lies in the inability to make creditors agree on the restructuring deal. The latest proposal from the ICMA has been suggested before and has some broad support, even if some fine turning of the new clauses for insertion in contracts would be required to deal with multiple bond issues and all debt. The proposed solution would bind all creditors to a vote that is agreed to by at least 75% of the creditors, instead of 100%. The idea is that this reduces the incentives to hold out. Some countries, such as the UK, already employ these clauses.</p>
<h2>Counter-productive?</h2>
<p>While this approach is promising, the trade-off is that debtor countries may default more readily knowing that restructuring can be agreed to more readily. This in turn may discourage creditors from lending in the first place. The new clauses, after all would not address the lack of enforceability of sovereign debt, and so we are left to see how they impact on the reputational mechanism instead.</p>
<p>The change in the voting threshold implies that the value of distressed debt will be higher, thus reducing the incentives of vulture funds to buy it. This can only be good. However, will the new clauses improve creditor coordination? And what if, instead of faster agreements, the bondholder composition becomes more concentrated and more creditors decide to hold out? The risk lies is not quite knowing whether a new regime would lead to a different, and more coordinated group of creditors, and not knowing which way they might act. </p>
<p>The second point to make here is that the revised contracts will have to wrestle with age-old dilemmas over the balance created in such debt deals. If bankruptcy laws favour the debtor too much, it creates incentives to misuse them and in turn discourages banks and investors from lending. If the law favours creditors too much, then it reduces the incentives to borrow money and reduces the potential for innovation and entrepreneurship. Sovereign states and the financiers know this only too well, and no single clause will be a cure-all for the kind of predicament faced by Argentina.</p><img src="https://counter.theconversation.com/content/31120/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Amrita Dhillon does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Sovereign debt is a crucial lubricant for growth, especially among emerging nations, and so it is equally crucial that we can ensure the interminable row over Argentina’s default is not repeated. Measures…Amrita Dhillon, Professor of Economics, King's College LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/302242014-08-07T05:19:46Z2014-08-07T05:19:46ZArgentina will survive default but indebted nations in Africa will not be so lucky<p>The Argentine government recently defaulted on its external debt. The country’s debt issues had been <a href="http://theconversation.com/for-argentina-debt-default-is-a-solution-not-a-problem-30010">building up for some time</a> and then, just over ten years ago the country’s newly-elected president, Néstor Kirchner, rejected responsibility for the external debts his predecessors had recklessly accumulated.</p>
<p>Specifically, Argentina’s neoliberal regimes of the 1990s had tried to sustain the peso one-to-one with the dollar. To paraphrase <a href="http://www.quotesandsayings.com/quotes/oscar-wilde/">Oscar Wilde’s comment on fox hunting</a>, this was a case of the unspeakable in pursuit of the unsustainable. Quite sensibly, Kirchner felt no obligation for his government to honour this foolishly acquired debt, which had brought no benefit to the vast majority of Argentines.</p>
<p>Instead of completely cancelling the US$80 billion debt, the new Argentine government negotiated with creditors over the amount they would repay. Far from some transgression of basic values, such renegotiations of debt occur quite commonly among creditors and debtors, both public and private (when corporations declare bankruptcy, for instance). After several years <a href="http://www.jubileeusa.org/truth-about-debt/vulturefunds/argentina.html">agreement was reached with creditors</a> holding over 90% of the debt to accept 30% repayment (to employ the current cliché, the creditors accepted a “<a href="http://www.investopedia.com/terms/h/haircut.asp">hair cut</a>”).</p>
<p>As these discussions proceeded, some hedge funds saw the possibility to make a fast buck (to use an old fashioned cliché) by purchasing Argentine debt with the intent to hold out for full payment. Foremost among these “vulture” debt speculators was MNL Capital that had bought its US$1.3 billion (face value) of bonds for far less than that amount, and far less than the 30% reached in the agreement. How much less we do not know because MNL Capital has not been notably forthcoming with such information (<a href="http://www.nmlcapital.com/">its website</a> is a blank page with a small logo and nothing more).</p>
<p>To achieve their speculative end, the directors at MNL Capital “went to court” in New York state, where some of the Argentine bonds were sold (establishing jurisdiction for the case, NML Capital vs. Argentina). To the surprise of many if not most, the judge ruled in favor of MNL Capital, and the US Supreme Court declined to review the case (de facto endorsing the lower court decision).</p>
<h2>Cash in hand</h2>
<p>What makes this lender-borrower dispute rather unique is that the cash to meet the pending debt obligation (less than US$600m) <a href="http://www.nasdaq.com/article/bank-of-new-york-mellon-still-has-argentina-payment-money-20140731-01160">sits in the Bank of New York Mellon</a> ready for collection by the holders of the 90% of the debt that was renegotiated. The funds remain frozen in the Mellon bank because the judge in the case ruled that the Argentine government could pay no creditor without also paying the “holdouts” – the speculators in MNL Capital; ergo, we have default by the formal definition.</p>
<p>This is the first case I have ever encountered in which the borrower has made the necessary debt service payment, but the lender is prohibited from collecting it. Even the International Monetary Fund, always in favour of full payments of sovereign debts, described itself as “<a href="http://www.imf.org/external/np/tr/2014/tr060514.htm">deeply concerned about the broad systemic implications</a>” of NML Capital v Argentina, with a stronger criticism of the court decision <a href="http://www.cepal.org/cgi-bin/getProd.asp?xml=/prensa/noticias/comunicados/3/53183/P53183.xml&xsl=/prensa/tpl-i/p6f.xsl&base=/prensa/tpl-i/top-bottom.xsl">made by Alicia Bárcena</a>, head of the United Nations Economic Commission for Latin America and the Caribbean (<a href="http://www.cepal.org/cgi-bin/getProd.asp?xml=/prensa/noticias/comunicados/3/53183/P53183.xml&xsl=/prensa/tpl-i/p6f.xsl&base=/prensa/tpl-i/top-bottom.xsl">CEPAL</a> in Spanish).</p>
<p>The IMF’s concern is hardly surprising because if the New York court decision becomes generally accepted legal practice, many countries face financial disaster now or in the future. This disaster does not immediately threaten or even focus on Argentina. The danger lies in the longer term implications for sovereign debt management.</p>
<h2>Willing and able</h2>
<p>But, first, the impact on Argentina: <a href="http://www.theguardian.com/world/2014/jul/31/argentina-defaults-debt-talks-break-down">according to the Guardian</a> “it could add more pain for Argentinians, with the economy already in recession”. It would appear that most bond speculators disagree; Argentine <a href="http://www.ft.com/cms/s/0/c9e3efac-18bc-11e4-a51a-00144feabdc0.html#axzz39PxDopoz">bond prices have risen</a>, not fallen, after the formal default.</p>
<p>The explanation should be obvious. The Argentine government wishes to pay the service on 90% of its debt, but is prevented from doing so by a court order. Any <em>compos mentis</em> speculator (aka “investor”) draws the obvious conclusion – the government is willing and financially able to service its debt.</p>
<p>Of course, the limited impact of the formal debt default does not mean all is well. Depending on your definition of “recession”, Argentina is either <a href="http://www.economist.com/blogs/americasview/2014/06/argentinas-economy">in it or will be soon</a>. But either way, debt is not the major factor. </p>
<p>Inflation, Argentina’s dominant economic problem, has little to do with tension over the external debt (the economy has been <a href="http://en.wikipedia.org/wiki/Economic_history_of_Argentina">prone to inflation, even the hyper version, for decades</a>), and it is no great secret that the Argentine economy rises and falls with the fortunes of its much larger neighbor, Brazil (the former economy about US$500 billion, the latter US$2.3 trillion).</p>
<p><strong>Follow the Leader: Argentina and Brazil</strong></p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=405&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=405&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=405&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=509&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=509&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=509&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Annualised quarterly growth rates.</span>
<span class="attribution"><a class="source" href="http://stats.oecd.org/index.aspx?queryid=350">OECD</a></span>
</figcaption>
</figure>
<h2>Real losers</h2>
<p>Poor countries, especially those in Africa, are the real losers from this whole fiasco. Unlike Argentina with its relatively diversified economy and skilled labour force, the sub-Saharan countries have few options. Their underdeveloped financial sectors and near-total dependence on primary product exports leave them heavily reliant on foreign borrowing.</p>
<p>As catalogued by <a href="http://blogs.wsj.com/moneybeat/2014/06/25/what-happens-when-the-the-vulture-funds-start-circling/">Daniel Huang in the Wall Street Journal</a> (hardly an anti-business source), three sub-Saharan countries have infamously suffered assaults by hedge funds – Zambia (by Donegal International, not the Irish car rally and head office in the British Virgin Islands, no website), Democratic Republic of the Congo (FG Hemisphere, New York based, which has a <a href="http://fgcap.net/">website</a>), and Republic of the Congo (Kensington International, Cayman Islands, no website). </p>
<p>The British government considered the first two of these so appalling that it over-ruled the court decisions granting the hedge funds their prey, the latter through the intervention of the Privy Council of England (apparently not all royalist relics are dysfunctional). Subsequently Parliament passed <a href="http://www.theguardian.com/business/2009/may/06/vulture-funds">legislation to clip the wings and claws of the vultures</a>.</p>
<p>There is a general principle in the affairs of finance – default by a small borrower is the debtor’s problem and default by a large borrower is the lender’s problem. During the Latin American debt crisis of the 1980s that principle was over-ruled by the US government, which prevented defaults by a variety of political and economic interventions.</p>
<p>The US government now lacks the power to do that again, and the rule is back in force. A global mechanism for sovereign default would make life easier for countries such as Argentina. For the poor countries of the earth it could be the difference between stagnation and development.</p><img src="https://counter.theconversation.com/content/30224/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Weeks does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Argentine government recently defaulted on its external debt. The country’s debt issues had been building up for some time and then, just over ten years ago the country’s newly-elected president, Néstor…John Weeks, Professor Emeritus, SOAS, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/300102014-07-31T23:19:12Z2014-07-31T23:19:12ZFor Argentina, debt default is a solution not a problem<figure><img src="https://images.theconversation.com/files/55457/original/f6r2kkf8-1406829483.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">No need for doom and gloom.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/mauriciomacri/14506939245">Mauricio Macri</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>Unless you just returned from holiday in some ultra-remote region lacking newspapers, television or internet access (is there such a place?), you will be aware the government of Argentina has <a href="http://www.bbc.co.uk/news/business-28578179">defaulted on its external debt</a>. </p>
<p>The immediate cause of the default was a New York federal court decision that an agreement reached between the Argentine government and creditors <a href="http://www.jubileeusa.org/truth-about-debt/vulturefunds/argentina.html">holding over 90%</a> of the country’s external debt was illegal.</p>
<p>The principal litigant bringing the case against the government holds less than US$2 billion of the Argentine debt, which by comparison makes a tail wagging a dog seem a credible anatomical interaction. This litigant, NML Capital, never lent a cent to the Argentine government (nor to any other). It acquired its one billion plus of Argentine bonds on the re-sale market, purchasing at far below face value.</p>
<p>Depending on your source of [mis-]information, you will think that this default is 1) the result of a feckless, spend-thrift government failing to accept responsibility for its actions (as argued, for example, <a href="http://www.forbes.com/sites/jamesglassman/2012/07/25/dont-mention-argentina-and-greece-in-the-same-breath/">in Forbes</a>), 2) the harbinger of deep <a href="http://www.cnbc.com/id/101875052">economic trouble for the Argentines</a>; and/or 3) the consequence of the <a href="http://jubileedebt.org.uk/actions/support-argentinas-fight-against-vulture-funds">predatory evil of “vulture” hedge funds</a>.</p>
<p>Taking these three in order, they are 1) false, 2) probably false, and 3) true but not terribly important. The current debt of the Argentine government was accumulated before 2003, much of it under the disastrous presidency of Carlos Menem (forced to resign in 1999) and three short-term successors (<a href="http://en.wikipedia.org/wiki/Fernando_De_la_R%C3%BAa">Fernando de la Rúa</a>, 1999 to end of 2001; <a href="http://en.wikipedia.org/wiki/Adolfo_Rodr%C3%ADguez_Sa%C3%A1">Adolfo Rodríguez Saá</a>, last two weeks of 2001; and <a href="http://en.wikipedia.org/wiki/Eduardo_Duhalde">Eduardo Duhalde</a>, 17 months to May 2003).</p>
<p>The massive debt accumulation (see chart below) resulted from the hapless attempt to maintain a one-to-one exchange rate between the national currency and the US dollar via a “<a href="http://www.investopedia.com/terms/c/currency_board.asp">currency board</a>”. This neoliberal bright idea legally links the amount of national currency in domestic circulation with the US dollars held by the central bank (in this case, the Banco Central de la Republica Argentina).</p>
<p>By the rules of this bone-headed currency “regime”, the national money supply must fall when US dollars flow out of the country (for example, if there is a trade deficit or capital flight). Contraction of the money supply invariably means contraction of the real economy. To avoid this, prior to May 2003 the government (under its revolving door of presidents) borrowed US dollars through sales of public bonds, driving the public debt up to almost 200% of national income (measured on the left hand axis of the chart).</p>
<p><strong>Public debt and GDP growth in Argentina, 2000-2013</strong></p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=385&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=385&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=385&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=484&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=484&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=484&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="http://data.worldbank.org/data-catalog/world-development-indicators">World Bank</a>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>This debt was not accumulated in pursuit of “populist” expenditures by a fiscally irresponsible government. On the contrary, not a centavo of the debt funded any public service or brought any benefit to people in Argentina. To the extent that the foreign currency acquired by the bond sales stayed in Argentina, it sat idle in the Banco Central. And when this extraordinarily misconceived and mismanaged currency regime inevitably collapsed, it brought the entire economy down with it, a decline of almost 5% in 2001 and 12% in 2002 (read from the right hand axis of the chart), plus runaway inflation that climbed over 100% during these years.</p>
<p>In the wake of this disaster generated by the neoliberal currency regime, Nestor Kirchner won the presidential election of 2003, succeeded by Cristina Fernandez de Kirchner 2007, who was overwhelmingly re-elected in 2011. Becoming president after the end of completely discredited neoliberal governments, Kirchner abandoned the “currency board” system and disowned the debt accumulated in a foolish attempt to sustain it.</p>
<h2>Why governments default</h2>
<p>This Argentine move demonstrates a general principle – most sovereign debt defaults are not the result of mismanagement or wild spending by sitting governments. Two centuries of debt “refunding” shows there to be at least three major motivations for defaulting on sovereign bonds, unrelated to excessive public spending.</p>
<p>First, we find many examples where debts were repudiated because they were accumulated in dubious circumstances under previous governments, and Argentina is an obvious example. A more extreme example is the cancelling at the <a href="http://en.wikipedia.org/wiki/Agreement_on_German_External_Debts">1953 London conference</a> of the external debt of the Federal Republic of Germany (holdover from the Nazi regime).</p>
<p>Second, global economic and political shocks can make it impossible for a government to service its debt (excellent source is the 1973 <a href="http://www.alibris.co.uk/The-Refunding-of-International-Debt-Henry-J-Bittermann/book/5617431">book by Henry Bittermann</a>). Obvious examples are the debt defaults by Latin American governments during the 1930s (due to a sharp fall in primary product prices) and the 1940s (collapse of international trade due to war).</p>
<p>Third, and being played out now in the euro zone, is public sector nationalisation of private debts. As I show in <a href="http://www.anthempress.com/economics-of-the-1-percent">economics of the 1%</a>, during 2009-2010 the Spain government, previously with the lowest debt-to-GDP ratio of major EU countries, refinanced all its failing banks. This created both an unsustainable fiscal deficit (where before it boasted a surplus) and a public debt it could not finance. </p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=413&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=413&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=413&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=519&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=519&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=519&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Augusto Pinochet with his patron Henry Kissinger.</span>
<span class="attribution"><a class="source" href="http://en.wikipedia.org/wiki/Augusto_Pinochet#mediaviewer/File:Reunión_Pinochet_-_Kissinger.jpg">Chile foreign ministry</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>This particular path to debt disaster was pioneered in the early 1980s by none other <a href="http://countrystudies.us/chile/67.htm">than the Pinochet regime in Chile</a>, under pressure from the US government (in value the largest nationalisation in Chilean history, far larger than anything the <a href="http://www.britannica.com/EBchecked/topic/16237/Salvador-Allende">socialist Salvador Allende</a> had done).</p>
<p>All this leads to an obvious conclusion – default serves as the solution to an otherwise intractable problem, an unsustainable foreign debt. The problem is not default, the problem is the absence of an international mechanism to bring it about in an orderly manner.</p><img src="https://counter.theconversation.com/content/30010/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Weeks does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Unless you just returned from holiday in some ultra-remote region lacking newspapers, television or internet access (is there such a place?), you will be aware the government of Argentina has defaulted…John Weeks, Professor Emeritus, SOAS, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/286232014-07-02T13:24:14Z2014-07-02T13:24:14ZArgentina’s vulture defeat shows courts have too much power<p>A <a href="http://www.reuters.com/article/2014/07/02/argentina-debt-idUSL2N0PC12920140702">missed debt repayment this week</a> means Argentina further extends its exclusion from the world’s capital markets. The country must find the money to repay all its creditors, or agree to a restructuring deal within 30 days, otherwise it will go into a technical default.</p>
<p>Argentina last defaulted on its debt repayments in 2001, following a prolonged economic recession and a period of rapid inflation. Twelve years on, the situation has come to a head once again after the US Supreme Court ruled in favour of <a href="http://www.buenosairesherald.com/article/163428/nml-capital-argentina-has-refused-to-negotiate">one of its remaining holdout creditors</a>, NML Capital.</p>
<p>NML is a “vulture” fund. Its business model requires it to buy defaulted debt cheap on the secondary market then sue debtors in distress for full repayment in US courts. </p>
<p>But the impact of the court’s decision will be felt far beyond Argentina. The fact US judges have taken such a proactive stand in the sovereign debt markets represents a radical change – and not for the better.</p>
<h2>Swap shop</h2>
<p>When a national government wishes to raise funds on international capital markets it issues sovereign bond contracts in foreign law. Private creditors buy these bonds, effectively transferring money to the debtor country. As these bonds are contracts, default or the failure to repay debt is therefore legally a breach of contract. </p>
<p>On breach it is not unusual for a court to order a defaulting debtor to repay its creditors in full, however international law protects sovereign assets from seizure. It is therefore almost impossible for creditors to collect from defaulting sovereigns – whether you invested in Russian sovereign bonds in the late 1990s, or Argentine ones in 2001, you were taking a clear risk. Usually most creditors negotiate debt swaps – voluntary exchanges of defaulted bonds for new bonds with lower face value payments. </p>
<p>Debt swaps are mutually beneficial. The country buys time to recover from the deep recession that often pre-empted the default. The repayments also signal a willingness to repay allowing the sovereign to regain access to primary capital markets. Bond holders are assured of a steady stream of payments and avoid uncertain and prolonged litigation. Something is generally considered to be better than nothing. In most cases, however, the success of swaps depends on sovereigns repaying vulture funds in full. </p>
<p>Argentina negotiated two debt swaps with 92.4% of its creditors, giving them 30% of what they were originally owed. Thus far, Argentina has kept up its repayments. However, in a break with market practice, Argentina resolutely refused to repay the vulture funds, on the grounds that their claims are extortionate and their refusal to accept what was offered other creditors. </p>
<p>To comply with the US decisions, Argentina must therefore default on bond repayments. Argentina has three further choices: avoid the US clearing system (and the jurisdiction of the US courts) and issue new debt in its own currency; <a href="http://www.bbc.co.uk/news/business-28052533">ignore the US courts</a>; or repay the vulture funds in full.</p>
<h2>The legal issues</h2>
<p>The US decisions will have wide implications for international debt markets.</p>
<p>The court has ruled that a debtor such as Argentina must treat all its creditors equally. In practice this means that the face value of all creditor claims must be repaid simultaneously – no longer can an indebted nation pay off some of its debts while hiding when the vulture funds send the bailiffs round. Another change gives creditors the right to find out a sovereign’s global assets that can be attached to satisfy seizure orders. </p>
<figure class="align-left zoomable">
<a href="https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/52891/original/jyv3pp49-1404305260.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">A balancing act.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/mikecogh/8035396680/in/photolist-df4vu5-MM4yH-d7NnwY-68BQZq-9y3EeR-6wPWLd-8AqBAj-6wKLzr-6vhunF-conrr3-7JtC9m-bUjXg2-6tqHVV-9BBizJ-6TDWPJ-bKzuZi-mbCT1P-bEzTE5-9gYB9p-7Rzvfv-6Tn4AN-BjrBE-7oL6Ct-4TwVqP-ajzocM-aMjMSH-nQG1yi-6ou7Gs-46w2Qt-dTdGh-au7dHK-8Q2bgF-o8bkG2-86ruND-3zexY-dVWdsa-eDEemS-2SaAQd-ecEUn-77vYMe-oHmNS-6EoKbA-cPVVC7-aqABeA-5XbNnQ-9485rB-7KnzZi-fzH5j9-2nzRw-j9UrNR">Michael Coghlan</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Courts generally tend to stay away from intervening in contractual disputes involving sophisticated investors in financial market transactions. The courts take the view that such investors must take their own protections for
investment risks. In sovereign bond disputes, courts have so far deferred to remedies specified in the sovereign bond contracts and market practice – the right to seize the commercial assets of a sovereign, the right to accelerated payments on default and negotiated debt swaps. </p>
<p>In the most significant move, the US judges have effectively decided to put themselves in charge. The supreme court’s ruling has established the use of judicial discretion to resolve contract disputes and debt crises. Judges, not markets, will decide what to do when a country doesn’t pay its debts. The unprecedented exercise of judicial discretion in customising a remedy to satisfy the claims of vulture funds is a game changer. </p>
<h2>Uncharted territory</h2>
<p>The Argentina affair has at least kicked off a necessary conversation on the regulation of sovereign debt markets. The debate has, however, been unhelpfully polarised, reflecting the oppositional dynamic of judicial decision-making itself. Argentina, backed by the rest of the world including the United States, Mexico and France, <a href="http://www.shearman.com/%7E/media/Files/Services/Argentine-Sovereign-Debt/2013/Arg4112842ArgentinavNML-Amicus120913.pdf">faces the vulture fund and the judges</a>. It’s an interesting story full of dramatic rhetoric, but the focus on individual protagonists is misplaced – they’re just doing what you might expect under the circumstances.</p>
<p>The deeper question concerns the significantly increased role of the courts in sovereign debt markets. Unlike informal rules of “market practice”, the law is binding and legitimate. Market practice made debt swaps possible but must now give way to judge-made law – a law that is customised to benefit one particular vulture fund at a time rather than the collective interests of creditors affected by default, the citizens of the debtor, or the wider region. In the longer term, the new rules will make it harder for countries to swap their debts for bonds with more forgiving terms, as was conventional for most debtors (including Argentina) in the past. Fewer debt swaps will mean more prolonged debt crises. </p>
<figure class="align-left zoomable">
<a href="https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=398&fit=crop&dpr=1 600w, https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=398&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=398&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/52893/original/w25fqwq5-1404305588.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Feeding time?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/nchill4x4/5129022466/in/photolist-8PezFQ-eLQFGK-6KoUEq-8tRwd6-4i96hP-i7htBK-depTXr-6BdfAY-4vMi2N-bv7viG-6qSp87-bWYwb4-dwgw1U-5EmC3B-5EmBYc-5EqUG1-4sk4u4-i7hufs-kaLnEV-4x6Dwp-m5EmMf-ybYcc-ybYc9-dupdjy-6ZgARb-6WRp4S-8P7jiE-gp35kY-6Zg73Z-4iuU9k-A38dd-7GLENu-dPcphG-615waj-8hL3LF-7X63dM-8J9nDu-6fRSzk-bYKzJw-bq928K-5W3eDB-611vzH-aH7iyF-bYKzxS-5zZj2K-hCMxux-aH7iNx-5YAD3b-nPBWFk-raGof">Nick Chill</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>The US Supreme Court decisions offer vulture funds a repayment option in the face of existing international protections that allow sovereigns to
effectively have their assets protected from creditors. In the face of a <a href="http://www.ft.com/cms/s/0/91723dc6-0044-11e4-8aaf-00144feab7de.html?siteedition=uk#axzz36JXFWxnY">“uniquely recalcitrant”</a> debtor, the courts have created an option of intervening in the way that they have. The problem therefore lies in the deep structural flaws that place the courts in the invidious position of acceding to vulture funds gaming the system. But courts don’t exist to solve structural problems – or at least, they haven’t evolved that way. That is what politicians are supposed to be for.</p>
<p>A century ago, judicial interventions failed to deal with the insolvencies of indebted US railway companies. Sensing the limitations of judge-made law, politicians took matters into their own hands and created what became the Chapter 11 corporate bankruptcy law (Arthur. H. Dean, 1940-41). Today, we have a similar problem at the international level – and a similar intervention is required. </p>
<p>We need to build a political consensus behind the idea of a formal
international debt resolution framework. No more ad-hoc decisions by judges. Things could be decided through a sustainable and transparent international sovereign bankruptcy process. This isn’t just a pipe dream – Nobel-winning economist Joseph Stiglitz is among those <a href="http://www.globalpolicy.org/component/content/article/209/42786.html">who have repeatedly proposed</a> such a framework.</p>
<p>In the interim, Argentina continues to be effectively shut out of primary capital markets. In the medium term, expect a significant increase in
litigation – the recent <a href="http://www.shearman.com/%7E/media/Files/Services/Argentine-Sovereign-Debt/2014/Arg88-2014-06-29-Motion-for-clarification.pdf">request for clarification</a> of the US decision by Euro Bondholders is a case in point. And that’s not all. The US Supreme Court’s decisions in favour of the vulture funds may be justified by the need to maintain market confidence but, paradoxically, they seem likely to diminish the certainty and predictability attached to debt issued under US law. </p><img src="https://counter.theconversation.com/content/28623/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Dania Thomas does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A missed debt repayment this week means Argentina further extends its exclusion from the world’s capital markets. The country must find the money to repay all its creditors, or agree to a restructuring…Dania Thomas, Lecturer in Business Law, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/283812014-06-30T05:03:06Z2014-06-30T05:03:06ZArgentina’s debt trail favours speculators and the super rich<figure><img src="https://images.theconversation.com/files/52307/original/mt7v48gv-1403752941.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The US Supreme Court's decision has received worldwide condemnation.</span> <span class="attribution"><a class="source" href="http://multimedia.aapnewswire.com.au/Search.aspx?search=argentina+protest">David Fernández/AAP</a></span></figcaption></figure><p>Argentina is facing the potential of a new financial crisis after it defied legal attempts to force it to repay US$1.33 billion in debt owed to the so-called “vulture” funds that have pursued the country for more than a decade.</p>
<p>Over the weekend the Argentine government proceeded with a $US539 million payment to creditors that had agreed to restructured debt terms following the country’s 2002 default. </p>
<p>But it has ignored a US Supreme Court order to pay out a group of mainly New York-based “hold out” hedge funds. These had refused the country’s restructured terms and are demanding a payment of $1.33 billion.</p>
<p>US Supreme Court Judge Thomas Griesa described Argentina’s payment to the restructured debt holders as illegal and “explosive”, ordering the Bank of New York Mellon <a href="http://www.bloomberg.com/news/2014-06-27/argentina-bond-fight-judge-says-he-will-nullify-bny-payment-1-.html">to return the money</a> to Argentina. The judge has pleaded with Argentine authorities to negotiate with the hedge funds to avoid a technical default. Argentina argues that paying both classes of creditor would also cause it to default.</p>
<h2>A brief history of debt</h2>
<p>The dramatic events have been brought about by the court’s decision on June 16 to quash an appeal by the Argentine government against an earlier decision forcing it to repay the hedge funds.</p>
<p><a href="https://theconversation.com/argentina-wins-brief-reprieve-from-default-but-the-vulture-funds-are-circling-10989">As I have written before</a>, the dispute dates back to the country’s US$100 billion debt default, the world’s largest. </p>
<p>Vulture funds are private financial institutions that speculate by investing in debt such as high-yield bonds and other financial securities that are close to defaulting. <a href="http://www.afdb.org/en/topics-and-sectors/initiatives-partnerships/african-legal-support-facility/vulture-funds-in-the-sovereign-debt-context/">According to the African Development Bank Group</a>, these financial institutions buy “… distressed debt on the secondary market, where it trades significantly below its face value, and then seek to recover the full amount, often through litigation”. They operate in a legal space that is highly favourable to them, often in the US or European courts.</p>
<p>On February 23 2012, US District <a href="http://en.mercopress.com/2012/11/22/argentina-s-outbursts-backfire-judge-griesa-orders-payment-to-holdout-bond-investors">Judge Griesa ruled that Argentina had infringed</a> upon the notion of “pari passu” or equal treatment provisions for all creditors when it paid bondholders who accepted debt restructure swaps in 2005 and 2010, while refusing to pay vulture funds.</p>
<p>At times, the saga has taken startling turns. In October 2012 the Argentine sailing ship ARA Libertad was detained by the Ghanaian government and prevented from leaving the Port of Tema, due to an injunction by US hedge fund NML Capital. However, the Argentine vessel managed to sail back to Argentina while court proceedings continued in US jurisdictions. </p>
<p>In November 2013, the US Second District Court, the jurisdiction where the original loans were contracted, ruled in favour of the holdout funds. Argentina responded by filing an appeal to the US Supreme Court in February 2014, which was finally rejected on June 16.</p>
<h2>The fallout</h2>
<p>The ramifications of this crisis are staggering. <a href="http://www.jubileeusa.org/whatwedo/debt-related-issues/vulturefunds/argentina.html">According to the USA Jubilee Network</a>, an organisation that calls for debt relief for poor countries:</p>
<blockquote>
<p>The decision will impact debt restructurings, poor country access to credit and propel predatory behaviour. The Court also ruled against Argentina in a related case involving the ability of hold-out creditors to locate the foreign assets of the sovereign nations they are suing. </p>
</blockquote>
<p>The vultures’ legal victory virtually means that they have been given free rein to target poor countries’ funds which are badly needed for financial recovery and economic and social development. The <a href="http://www.jubileeusa.org/whatwedo/debt-related-issues/vulturefunds/argentina.html">Jubilee Network again</a>: </p>
<blockquote>
<p>The orders here give a preference to a minority of holdout creditors like Elliott at the expense of the majority of creditors who agreed to give relief to a sovereign facing economic difficulties … If this type of relief becomes the law, bondholders who restructure their debt - a group that consists of numerous individuals and pension funds - could be deprived of payments on their bonds, thus resulting in economic hardship to many people.</p>
</blockquote>
<h2>International consequences</h2>
<p>The Union of South American Nations (UNASUR) has criticised the effects of the decision on the international financial system. UNASAR warned that the “legalisation” of such behaviour threatens the stability of the system. </p>
<p><a href="http://www.pressenza.com/2014/06/uruguays-president-mujica-says-vulture-funds-argentinas-oil/">Uruguay’s President Mujica expressed his deep concern</a> and suggested the real intentions of the vulture funds “ … are related to the Vaca Muerta oilfields in the Province of Neuquen”.</p>
<p>The court ruling is quite unprecedented given that it went against a decision on a similar claim made in Europe by another vulture fund on Argentine assets. On July 11 2013, <a href="http://www.jubileeusa.org/whatwedo/debt-related-issues/vulturefunds/argentina.html">German courts rejected hedge fund claims</a> on Argentine assets in Germany. </p>
<p>The $1.33 billion Argentina is being forced to pay back to the New York-based hedge funds represents a staggering 1,000% profit margin. Of further concern is the fact that the <a href="http://www.theguardian.com/business/2014/jun/24/argentina-hits-back-vultur-funds-newspaper-advert">vulture funds represented 1.6% of bondholders</a>, hence jeopardising 92.4% of bondholders who voluntarily accepted a restructure.</p>
<p>Meanwhile, the high-level stakes played by Judge Griesa and the Argentine government continue to spring surprises. Argentina’s financial daily <a href="http://www.ambito.com/noticia.asp?id=747216">Ambito Financiero</a> reported that if the Bank of New York Mellon does not make its payments to bondholders according to the instructions directed by Casa Rosada the bank would be in breach of its obligations as a financial representative of the Argentine government. </p>
<p>This would mean that payments to creditors could then be shifted to a new geographical jurisdiction outside the US. This could well be Buenos Aires, as earlier requested by the Argentine government of its bondholders. It is no surprise, therefore, that Judge Griesa asked both Argentina and the vulture funds to negotiate. </p>
<p>The chess game of financial brinkmanship continues with numerous twists and turns. In the meantime, the international financial community and many indebted third world nations await its outcome. </p><img src="https://counter.theconversation.com/content/28381/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexis Sergio Esposto does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Argentina is facing the potential of a new financial crisis after it defied legal attempts to force it to repay US$1.33 billion in debt owed to the so-called “vulture” funds that have pursued the country…Alexis Sergio Esposto, Senior Lecturer, Economics, Swinburne University of TechnologyLicensed as Creative Commons – attribution, no derivatives.