Opinion

Felix Salmon

The silly war on vulture funds

By Felix Salmon
May 7, 2009

I was on The World Today this morning, talking about vulture funds:

The bill they’re talking about is this one, which is very similar to the Stop Vulture Funds Act being pushed by Maxine Waters in the US. Essentially it says that if you lend money to a country you have the right to get your money back — but if you then sell that loan to someone else after it has gone into default, the person you sold it to does not have the right to be repaid in full, and instead can only be awarded the amount they originally paid for the debt, plus a small set interest rate.

In other words, the single greatest innovation in the history of debt capital markets — the idea that obligations can be traded, rather than just being held to maturity or litigated upon default — is destroyed at a stroke.

What’s more, the problem these bills are trying to solve is absolutely minuscule. Not only are vulture funds settling their debts for three cents on the dollar, but they more generally have had a very hard time indeed successfully collecting on court judgments around the world. That’s why litigation is a last resort for vultures: anybody who thinks that they buy up this debt with the intention of litigating for repayment in full simply doesn’t understand the business model.

The good news, however, is that neither the UK nor the US bill has any chance of making it into law: the governments in both countries, for all that they’re nominally left-wing, would never support either piece of legislation. This is basically theatre on the part of lawmakers, not a serious and thought-through attempt to rewrite the international financial architecture. If it were, maybe the lawmakers in question might have asked developing countries what they thought of this legislation. And they might well have been surprised at the answer, which is that countries want no part of any act which might hinder their access to capital or their equal-player status on the world stage.

Anti-vulture-fund legislation like this is paternalism of the worst kind: it might be well intentioned, but at heart it’s a bunch of ill-informed northerners telling impoverished southerners what’s good for them. If and when vulture funds ever become a real problem — which I doubt will ever happen — then I fully expect to see the afflicted countries coming up with their own suggested solutions. In the meantime, let’s not exacerbate the plight of those countries by cutting off whatever access to international capital that they currently enjoy.

Update: Sandrew has a very good comment.

Comments
14 comments so far | RSS Comments RSS

Obligations can be and should traded, I don’t think anyone should put unreasonable limits or regulations on this, this can change whole game. Holding obligations simply to maturity is like sitting on cash and not investing it. It’s a waste and nothing new is being created in such an environment. I hope this won’t make into law.

Posted by David Dzidzikashvili | Report as abusive
 

The discomfort people feel toward vulture funds strikes me as rather a lot like (part of) the discomfort people feel toward record companies and pharmaceuticals. Each is playing the different games in the same way: they’re both playing for the tails of the distribution. Now these same people may have other good reasons to hate the recording and pharma industries, but claims that these groups “gouge” artists and patients (and debtors in the case of the vultures) on the basis that one particular “hit” has high margins/returns is a bit myopic.

 

Wouldn’t this outlaw the bill collection industry?

Posted by KenG | Report as abusive
 

Lots and lots of loans can’t be traded. It’s a fairly standard covenant in a lot of corporate obligations. If you are happy with the idea of having a traded obligation, you issue a bond. If you only want to owe money to a specific counterparty that you have a relationship with, then you take out a loan.

It would probably be a good thing if it were to become a standard covenant in government-to-government lending to emerging market countries like the Romania/Zambia loan in the Donegal case; you are not seriously trying to tell me that when Zambia borrowed money on an easy-terms vans-for-grain deal with a Communist state, it envisaged that the eventual repayment negotiations would be conducted with a hedge fund. Get off your high horse.

and this is a bit disingenuous, frankly:

[That’s why litigation is a last resort for vultures: anybody who thinks that they buy up this debt with the intention of litigating for repayment in full simply doesn’t understand the business model]

So their business model is to ask nicely? While the vulture funds always hope to get bought out or settle, the *threat* of litigation is really quite obviously key to the whole business model. You might as well say that busting kneecaps is a last resort for loan sharks, so anyone who thinks loan sharks intend to be violent simply doesn’t understand the business model.

(also, Zambia? “access to capital?” “equal-player status on the world stage?” these are HIPCs we’re talking about here, not Mexico or Argentina or somewhere.)

Posted by dsquared | Report as abusive
 

“It would probably be a good thing if it were to become a standard covenant in government-to-government lending to emerging market countries like the Romania/Zambia loan in the Donegal case….”

There are reasons why the sort of covenant you imagine is not standard in such cases, and the reasons will apply however much you might want to dream about “good things.”

Think nice enough thoughts and you can fly off to Neverland, right?

 

Unfortunately, dsquared, at least in the UK, they *are* talking about Argentina…

Posted by Felix Salmon | Report as abusive
 

Felix,

These “vulture funds” are doing on an international scale in essence what distressed-assets funds do in a more domestic contexts.

Such as the context of the Chrysler bankruptcy proceedings, right? Is railing against the one group “sillier” than railing against the other?

 

Felix,

You are prehaps the most read financial blogger of your generation and you’ve earned that spot with indepth reporting covering complex financial topics. I must agree with other posters reguarding your seemingly polar opposite views reguarding the subordinate debt holders getting a larger recovery than senior-secured holders in the case of Chrysler and your defence of vulture funds.

How will companies in risky industries get the capital they need if investors at the top of the capital structue can’t handcuff their capital to real underlying assets?

Keep up the great work!

Posted by y2kurtus | Report as abusive
 

[There are reasons why the sort of covenant you imagine is not standard in such cases,]

Patronising much? In fact, you don’t state these “reasons”, because you can’t because there aren’t any particularly valid ones. Just as there was no particular reason why sovereign bonds didn’t include orderly renegotiation clauses and provision for majority voting before about 2005 – it was just that nobody had thought to include them, and nobody wanted to be the first to include them.

In fact, there’s absolutely no reason to not include a no-transfers covenant in bilateral government lending, and considerable reasons of public policy to want to do so. There really are very few legitimate reasons why a borrower or lender might want their loans to be transferable. *Private sector lending* might be a totally different thing, but the majority of vulture fund litigation takes place in contexts like Donegal/Zambia, and countries like Zambia typically have very few or no private sector creditors.

If you are at this point thinking that maybe you are talking to someone who knows *really quite a lot* about sovereign debt (say, someone who was a civil servant dealing with international bond covenants for five years), you are right. Perhaps if you think some thoughts about this a little more, you can fly off to a land where people know what they’re talking about.

Posted by dsquared | Report as abusive
 

There are many reasons a borrower or lender would want their loans to be transferable. Lenders want the option of selling their loans if even at a loss and borrowers get better terms as a result of their loans being transferable because a broader universe of investors will buy them, at issue in the primary market and post issue in the secondary market.

There does not seem to be support for the statement that the majority of litigation takes place in the context of government to government loans. According to the IMF literature, the majority of sovereign debt litigation involves commercial debt, not bilateral.

And Zambia used to have plenty of commercial creditors. They all sold their debt back to the government debtor, however, at eleven percent of principal… much less than what the Paris Club creditors were requiring at the time.

African countries need more government and private sector loans, not less. And if making government to government loans transferable is so bad, why do all Paris Club reschedulings continue to provide for their transfer and conversion?

It is fantasy to think that African countries can get along just with bilateral assistance.

The intention of multi and bilateral financing is to graduate sovereign borrowers from development assistance to the capital markets. Setting a different standard for severely indebted countries is not going to assist this effort. It will simply retard their progress.

Zambia wants more, not fewer, creditors. The idea that African countries do not want creditors is very strange. Ghana, Congo and Ivory coast have recently placed bonds in the market and other countries will soon. African governments and companies need more loans and investors in them, not less. Their bonds and debts need to be transferable to make it possible for investors to exit their positions. This supports their price and the credit rating of the debtors.

Posted by Lambert | Report as abusive
 

Nice round-up Lambert.

 

On Zambian non-government creditors – no, you’re wrong. They were never more than a tiny fraction of the intergovernment and multilateral debt and were bought back specifically because they were so small.

More generally – have you not noticed, lads, the world has changed a bit? The days when this neoliberal guff about the benign and productive nature of international bond markets are in the past. To be talking about “the credit rating of the debtors” at this late date is to be seriously missing the point. The problem these days is the lack of credibility of the bond markets in Zambia, not the credibility of Zambia in the bond markets.

Posted by dsquared | Report as abusive
 

It is hard to understand this position when it is only in the past three years that sub-Saharan governments are accessing the bond markets with success.

In any event, far more debt is loaned each year as export finance and trade debt, not in bond issues… The whole issue of collective clauses in respect of severely indebted lower income countries is largely irrelevant.

Nor is the lack of commercial credits something to relish… A lack of commercial credit is causing Zambia far more problems than vultures ever did or will…

The reason commercial credits to Zambia (and Africa generally) were never more than a fraction of the total debt is because noone would export without sovereign guarantees… Why? Because their credit was bad. When the debts defaulted, the guarantees came into play and voila, sovereign debt.

Another reason the offical debt ballooned was that the bilateral (read official export credit agencies) and multilateral lenders kept accruing and compounding interest for thirty years and not rapidly writing it down and forgiving or selling back as the commercial creditors did…

The World Bank actually loaned many of the sub-saharan governments money to service debt to themselves… to preserve their credit rating.

The bilaterals and multilaterals did not cancel the debts they were owed until it became embarrassing that their debt service from Africa began exceeding their loans to Africa…

And to imply that Zambia’s credit rating means nothing to the world or Zambia is just silly…

Posted by Lambert | Report as abusive
 

I have no problem with a bond holder collecting debt whether it’s the original lender or a collection agency. What I have a problem with is and the proposed laws are designed to prevent is business cannot collect while the people are starving to death and receiving international aid. For example if a homeless man who was starving owed you ten dollars and I gave him a dollar for food so he would have food that day. Would you go over and take that dollar from him? Some would, but I would try and stop you. Same difference… Just its a whole country. When he gets back on his feet I have no problem with you collecting your money due.

Posted by Imagesplus | Report as abusive
 

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