Vultures play an important role in nature, though it’s one that strikes many as revolting. So it is in finance. In times of crisis, vulture investors swoop in to buy the cheapest, most troubled assets, giving desperate sellers an opportunity to exit. The investors get a chance to profit — from other peoples’ disasters. Few would begrudge the billions that hedge funds have earned for taking the risk of purchasing Lehman Brothers debt after the company’s bankruptcy in 2008. But the aggressive measures vultures have taken to recover money owed by struggling governments, including an epic battle over Argentina’s debt, have prompted concerns about the power of these investors to disrupt economies.
It took 15 years for Argentina to settle a dispute with a group of creditors who, after the nation’s 2001 default, refused to accept new securities worth about a third of the original value. The holdout bondholders were led by Paul Singer, head of the $27 billion hedge fund Elliott Management. Argentina went into default again in 2014, after the U.S. Supreme Court let stand lower court rulings requiring it to pay Singer’s group $1.6 billion in full and to not pay creditors who had accepted the marked-down bonds until then. Under the new government of President Mauricio Macri, Argentina negotiated an agreement to pay 75 percent of principal and interest on full claims. Amid Greece’s financial troubles in 2015, vulture investors bought its distressed government bonds, betting correctly that the country would reach a deal with its creditors to avoid default.
The most benign version of vulture investing involves buying liabilities of struggling companies, such as American Airlines or the Motors Liquidation Co. spun off from General Motors, sometimes for a few cents on the dollar, with the hope that the investments will regain some of their lost value as the companies restructure or sell assets to repay creditors. Much more controversial is the trade in government bonds, also known as sovereign debt. The practice is estimated to have returned vultures as much as 20 times their original investment. Vulture funds got their start during the Latin American debt crisis in the 1980s. Commercial banks swapped their bad loans to Latin American governments for so-called Brady Bonds, tradable instruments that they then sold on the secondary market. Those governments, still deeply in debt and not wanting to repeatedly default because it would impair their ability to borrow again, asked their new creditors to accept new terms, usually a longer period to repay a reduced amount of debt. Most agreed, figuring something was better than nothing. The pioneers of vulture investing, Kenneth Dart, heir to the Dart Container fortune, and Jay Newman, who eventually joined Elliott, refused. Instead, they sued for full repayment with interest, succeeding in Peru, Brazil and Panama. These and other vultures soon moved on to Africa, buying the debt of the Republic of Congo, Liberia, Ivory Coast and Zambia and taking them to court.
Governments struggling with debt argue that their creditors should share in the hardship afflicting their countries. When Gordon Brown was the U.K. chancellor of the exchequer, he argued that since debt relief was necessary for poor countries to educate their children and lift citizens out of poverty, vulture funds’ tactics were “morally outrageous.” Critics of the vulture funds say their success in the Argentina case could make it harder for distressed countries to restructure debt by encouraging holdouts. But in fact, since 2003 most government bonds have included a clause binding creditors to accept any terms that a supermajority of lenders agrees to. For their part, vultures say that they are simply standing up for their right to get paid and enforcing the rules of business. Singer argues that a government’s unwillingness to honor debts is a sign of wider corruption that should be exposed.
The Reference Shelf
- A U.S. Congressional Research Service report on Argentina’s defaulted sovereign debt.
- A study by German researchers documenting a rise in lawsuits filed against defaulting sovereigns since 1976.
- A Moody’s analysis of the role of holdouts creditors in sovereign debt restructurings.
- A paper in the Duke University law review, co-authored by one of Argentina’s lawyers, tracing the legal battles between governments and vulture investors.
- A Bloomberg BusinessWeek profile of Paul Singer and his fight with Argentina.
- A paper by Harvard’s Laura Alfaro suggests Argentina’s case will have a limited effect on future sovereign debt restructurings.
First published Oct. 1, 2014
To contact the editor responsible for this QuickTake:
Lisa Beyer at email@example.com