A Short History of Vultures

When Argentina defaulted on its debt for the second time in 13 years this week, the financial world was shocked, both by the default itself and, perhaps even more so, by the fact that a small minority of debt holders was willing to torpedo Argentina’s debt restructuring. But while the fight between Buenos Aires and its creditors may be in the headlines now, it’s not a new story. It  began 18 years ago with a perversion of international law in a New York City court and a then-obscure hedge fund that was called a vulture.*

One firm in particular deserves the blame for Argentina’s current situation — or kudos for its innovation, depending on how you look at it. In 1977, Paul Singer founded the hedge fund Elliott Associates L.P. with $1.3 million from friends and family. For nearly two decades, the firm grew by investing in various equities markets. But in 1995 Elliott Associates transformed from just another New York City hedge fund to a pioneer in the world of international finance. And today, 19 years later, the newest iteration of the same fund has played a crucial role in bringing Argentina to default.

In October 1995, Elliott Associates L.P. purchased approximately $28.7 million of Panamanian sovereign debt for the discounted price of $17.5 million. The banks holding those bonds, a group that included heavy hitters like Citi and Credit Suisse, had given up on repayment from Panama. To cut their losses they sold their holdings to Elliott.

When Panama’s government asked for a restructuring of its foreign debt in 1995, the vast majority of its bondholders agreed. Not Elliott. In July 1996, Elliott Associates, represented by one of the world’s most high-profile securities law firms, filed a lawsuit against Panama in a New York district court seeking full repayment of the original $28.7 million — plus interest and fees. The case made its way from a district court in Manhattan to the New York State Supreme Court, which sided with Elliott. Panama’s government had to pay the firm over $57 million, with an additional $14 million going to other creditors.

It was a groundbreaking moment in the modern history of finance. By taking the case to a New York district court, Elliott broke with long-standing international law and custom, according to which sovereign governments are not sued in regular courts meant to deal with questions internal to a nation state. Further, the presiding judge accepted the case — another break with custom. It set the stage for two decades of such cases, including Argentina’s default this week.

When Elliott’s case against Panama upended established international norms about how to negotiate sovereign default, journalists and researchers didn’t pay much attention. But Wall Street did. Following Elliott’s victory, other funds emerged trying the same strategy. Dart Container Corp and EM Ltd., both linked to Kenneth Dart, one of the most famous names in the world of vulture funds. NML Capital, a Cayman Islands-based fund associated with Elliott also got into the game.** Gramercy Advisors, a Greenwich, Connecticut-based firm, focused on Ecuadorian and Russian debt.

As these firms emerged, so did a new moniker: vulture funds. The name may sound disparaging, but it was not invented by Argentina or other debtors.
Wall Street’s older firms came up with the name.*** They could find a profit out of slim pickings.

The emergence of the vulture funds with the 1996 Elliott Associates, L.P. v. Republic of Panama case opened up a new legal option to force sovereign governments to pay the full value of their debts (plus interest), rather than the discounted amounts arrived at through negotiations arbitrated by the International Monetary Fund and other international institutions.

The strategy born in 1996 is the same today, but the prize is much bigger. The face value of the discounted Argentine debt that Elliott bought after the country’s 2001 default for $48 million is today $630 million. The fund wants repayment for the full value of the debt to all of Argentina’s creditors, as it did in 1995 with Panama.**** This amounts to $1.5 billion, which could rise to $3 billion including interests and fees.

The 1996 decision was a departure from how the international banking system handled debt restructuring of what were mostly poor countries (albeit often with very rich elites) in the sovereign debt crises of the 1970s and 1980s. The International Monetary Fund (IMF), the Paris Club, and other international sovereign debt-related institutions had come to the understanding with creditor banks in the late 1970s and early 1980s that they could not expect re-payment in full. In fact, in 1996 the IMF and World Bank implemented a special debt relief program based on the recognition by lenders that at least 46 highly indebted governments would not be able to repay their debts. In the Panama case, as in Argentina’s today, the banks had already accepted that they would withstand major losses.

The original debt holders — major banks like Citi, Credit Suisse, and others — had the resources to take Panama to court to try to enforce repayment. But they did not, because, at the time, those were not the rules of the game. The banks felt comfortable relying on the intermediation of the IMF and other international financial institutions. International law is weak law, and so is comity, the customary practice in the international system that assumes mutual respect among sovereign governments. These powerful banks recognized the importance of this kind of law for the functioning of the inter-state system, and hence, in the long run, for their own profits. Further, the banks recognized that sovereign debt differs from corporate, mortgage, or any other kind because of its ability to drag down a whole economy, including its healthy components.

When Elliott forced repayment on Panama, there should have been a robust public debate about the firm’s claim against a sovereign country in a local court and about the judge’s decision to accept that claim. After all, a sovereign’s money is technically its citizens’. Making the Panamanian government pay for the full value of the debt, plus interest, even as the major creditors accepted a discounted payment, meant handing citizens’ money to a hedge fund rather than investing in, for example, Panama’s roads, schools, or social welfare programs. Proponents of repayment argue that, done in good faith, it should have resulted in better credit ratings and therefore more investment in Panama — or Argentina. But because creditors had already agreed to accept the losses, this already questionable argument becomes irrelevant.

Elliott and other vulture funds have employed the same legal innovation used to squeeze Panama in 1996 again and again. Mostly, the funds have been successful. In 1998 alone, vulture funds took Ecuador, Ivory Coast, Poland, Congo, Vietnam, and other countries to court demanding payment on defaulted debt.***** Further, in what became a de facto, if not necessarily legal, precedent that affects the current Argentina case, the firm has gotten legal injunctions preventing creditors in Canada, the Netherlands, Germany, Luxembourg, and Belgium from collecting before Elliott did. In the current case, the judge in a New York City court enabled Elliott to prevent Argentina from paying the other creditors — who account for over 90 percent of its debt holders — without paying Elliott.

Elliott’s 1996 victory was significant, but there have been other important cases since, including the firm’s most recent win against Argentina. In 2012, Judge Thomas Griesa of the Southern District Court of New York ruled that whenever Argentina paid the majority of its creditors it would have to pay its holdouts, too. The U.S. Supreme Court rejected Argentina’s appeal. This case has been yet another massive step toward enabling private firms to sue sovereign governments in regular courts, rather than going to international financial institutions for arbitration.

Occasionally, vulture fund strategy did not work and courts stood up for sovereign governments. In 1996, soon after its successful move on the Panamanian
government, Elliott bought $20.7 million of Peruvian debt for $11.4 million. As usual, Elliott sued for the full value, plus interest. Initially, the New York southern district court ruled in Peru’s favor. The judge found that creditors had some responsibility for taking on bad debts. But the U.S. Court of Appeals in New York City reversed the verdict and, in the end, the parties settled the case.******

There may be hope, though. On July 31 there was a first step towards reversing the precedent that began in 1996. Argentina indicated that it might take its fight with the vulture funds to the International Court of Justice in The Hague. That, rather than a New York court — or even the United States Supreme Court — is the proper venue for taking on a small number of funds that are keeping the vast majority of its creditors from being paid and holding a country ransom.

* Correction: Elliott has not “called itself a vulture.” An earlier version of this article stated that it did. (Return to reading.)

**Correction: Elliott’s Cayman Islands-based subsidiary is called NML Captial. An earlier version of the article stated that Elliott’s subsidiary is MNL Ltd. (Return to reading.)

*** Correction, Oct. 9, 2014: So-called vulture funds did not embrace the moniker. An earlier version of this article stated that they did. (Return to reading.)

**** Clarification, Oct. 9, 2014: Elliott owns approximately half of Argentina’s $1.5 billion in debt. An earlier version of this article suggested that Elliott owned the full value. (Return to reading.)

***** Correction, Oct. 9, 2014: Elliott has not sued Ecuador, Ivroy Coast or Poland. An earlier version of this article attributed those 1998 lawsuits to Elliott. They were brought by other investment firms. (Return to reading.)

****** Correction, Oct. 9, 2014: While a district judge found in Peru’s favor in 1996, a Circuit Court reversed the decision. An earlier version of this article reversed this sequence of events. (Return to reading.)

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