Rich investors are winning big, but the case sets an awful precedent.
As a personification of “the rich getting richer,” Kenneth Dart is in a class by himself. A member of a reclusive, strife-ridden Michigan family that made its fortune from the manufacture of Styrofoam cups, Dart now controls a multinational empire—his net worth was estimated a couple of years ago at $6.6 billion—from a base in the Cayman Islands. According to one of his brothers, from whom he became estranged, he once considered making his home on his 220-foot yacht, which was armored to withstand torpedo fire. He escaped federal tax liability by renouncing his U.S. citizenship and becoming a citizen of Belize; he gained notoriety in the 1990s when he sought to become a Belizean consul based in Sarasota, Florida, where his parents, wife, and children lived.
The latest of Dart’s many windfalls is about to materialize in one of his specialties—squeezing profits from countries that have essentially gone bust. He made a tidy sum in 2012 on Greek government bonds, and now he stands to earn another packet on Argentina, a decade and a half after its catastrophic collapse and default on its debt. The newly-elected Argentine president, Mauricio Macri, has struck a generous settlement with Dart and other investors who put the country in a severe financial bind by filing lawsuits over its default.
This is no mere iniquity. The implications are global—and disquieting. The way Argentina’s debt saga is ending bodes ill for future cases of countries that fall into financial distress, because investors now have a clear incentive to pursue aggressive strategies similar to the approach taken by Dart. Not that Macri should be blamed; he is rightly drawing praise for taking action that is necessary for his country’s economic revival. But the difficulties for other countries that need debt relief will be all the greater. The case for reform of international rules governing such crises has never been stronger.
A look at what Dart did in Argentina explains why he is often called a “vulture investor”—and why the success of vulture investors has convinced economists at the International Monetary Fund, among others, that a better system is needed for countries that get over their heads in debt. Unsurprisingly, a major part in the Argentine drama was also played by the most famously litigious vulture of all, billionaire Paul Singer, who heads a New York hedge fund. Like Dart, Singer reaped hundreds of millions of dollars in profits on bonds of countries stricken by debt crises in the 1990s; their targets included countries such as Peru, Brazil, Nicaragua and Congo.
Recall that in 2001, Argentina was hurtling toward one of the worst financial and political crises in history. The country had once been the darling of Wall Street, which happily helped Buenos Aires borrow tens of billions of dollars. But the Argentine economy was mired in recession with no easy escape, and the burden of repaying principal and interest on $100 billion in debt was proving too heavy.
For the vultures, this was an opportunity to make a killing. They bought loads of Argentine bonds, which were then trading at pennies on the dollar. Even though the economy crashed at the end of 2001, and the government declared a halt to payments on its bonds, the vultures had a plan; indeed, some of their bond purchases came after the default. They were going to make Argentina pay as close to the full face amount of their bonds, plus interest, as possible—and they had a hunch that the law might eventually work in their favor. Boy, were they right.
The vultures rejected a deal that Argentina gave to its bondholders in 2005, which provided about 33 cents on the dollar. (In U.S. dollar terms, the Argentine economy had shrunk by about two-thirds, so this wasn’t quite as unreasonable as it may sound.) Even though more than 90% of the bondholders ended up accepting Argentina’s terms (after a second offer in 2010), the vultures held out for more—lots more.
Since Argentina had sold many of its bonds in New York to big financial institutions, disputes were subject to U.S. law, and the vultures could take advantage of the American legal system to press their claims. Sure enough, the federal judge overseeing the litigation, Thomas Griesa, ruled that they should be paid. Not that anyone could force Argentina to hand over money; a sovereign government is pretty well protected against foreign legal judgments that it deems invalid, and most of its assets abroad (embassies, for example) are immune from seizure. But the vultures’ lawyers skillfully used the courts to harass Buenos Aires — filing claims against overseas accounts belonging to the Argentine central bank, for example, and even seizing money from a Science Ministry account at a U.S. bank that was intended to pay for telescopes. In addition to making it risky for Argentine government-related entities to operate internationally, this litigation made it impossible for the Argentine government to raise new funds in international bond markets. Nonetheless, the Argentines remained steadfast in refusing to bow to the vultures’ demands or the U.S. court judgments.
The transformative event was a 2012 ruling by Judge Griesa that was the legal equivalent of putting Argentina at the mercy of gunboat diplomacy. (The term refers to the practice, common during the age of imperialism, of dispatching militaries to enforce financial claims.) Invoking certain legal wording in bond contracts, the judge decreed that as long as Argentina continued to deny the vultures payment on their claims, it would be forbidden to continue paying principal and interest to the bondholders who had accepted the earlier deals. Not only that, the judge put teeth into his ruling, by issuing an injunction prohibiting banks and other financial institutions from taking any action that would violate it.
Many legal experts expressed perplexity at the reasoning in Griesa’s ruling, not least because it threatened the rights of bondholders who had accepted Argentina’s earlier deals to collect what they were owed. What sane bondholder would go along with a debt restructuring offer in the future, given the risk that a single holdout might be able to block payments under the new terms? At the IMF, anguish was profound, enough so that Fund officials planned to enter an Amicus Curiae (friend of the court) brief urging the Supreme Court to overturn the decision. But the High Court declined to even consider the appeal. The mutually destructive stalemate continued, with former president Christina Kirchner vowing never to surrender to “financial terrorism.”
Enter Macri, whose victory last November marked a sea change in Argentine policy from strident, nationalistic leftism to an approach favoring re-integration with the global economy. In recognition of the benefits Buenos Aires would reap by folding its losing hand in the legal battle, the new president promptly negotiated deals with the vultures and other holdouts, giving them much—though not all—of what they were demanding. To Judge Griesa’s credit, he helped nudge these deals along, by threatening to lift his injunction if the holdouts failed to negotiate in good faith.
However much the settlements may help Argentina, the rewards for the vultures are gobsmacking. It is impossible to say with precision how much each is making, because the depressed prices at which they bought the bonds are not publicly disclosed. But Singer, he vulture-in-chief (his firm was lead plaintiff in the case), stands to collect $2.4 billion—a gain of about 10 to 15 times his firm’s original investment, according to the Wall Street Journal. Even for those who are ending up with less, the returns are hardly shabby.
It’s all well and good to celebrate this outcome as Argentina finally closing a sorry episode in its history, and dismiss the vultures’ bonanza as a bitter pill that Buenos Aires must swallow for the sake of improving its economic fortunes. But an appalling precedent has been set.
The next time a country needs to ask private creditors for a significant amount of debt relief, market participants will remember how spectacularly lucrative it was for Singer et al to hold out against Argentina’s original deal. They will ask themselves why anybody should settle for some write-down of their claims rather than pursue litigation for full payment. And they will feel emboldened by the knowledge that a court ruling in a very important jurisdiction could be used to enforce their demands. As Anna Gelpern, a Georgetown Law School professor who specializes in sovereign debt issues, wrote last week, “the [Argentine] case has produced and tested an immensely potent weapon that a small minority of creditors can now use to hold countries and the rest of their creditors hostage.”
The upshot is a worsening of a system that was already deeply flawed. Countries sometimes find themselves owing more to creditors than they can reasonably afford to pay—perhaps because of their own irresponsibility, perhaps because of bad luck, perhaps because of a combination of the two. Yet at the international level, there is no equivalent to the domestic bankruptcy laws that apply to individuals and companies. Whereas those domestic laws properly recognize the necessity of forcing all creditors to accept less than the full amount of their contractual rights, so that debtors can get a second chance while creditors receive equitable treatment, countries operate in a much wilder and woollier legal environment. Argentina’s tale shows how unjust, and inimical to public interest, the system is becoming.
The vultures and their apologists insist that the hard-nosed tactics of creditors like Singer and Dart are broadly beneficial—a classic case of greed being good. According to this view, the vultures help force countries to abide by the rule of law and honor debt obligations in accord with contractual terms. That in turn leads to more capital flowing where it is needed, and discourages the recipients from using that capital irresponsibly.
This argument is valid up to a point, but it is based on the same pro-creditor fundamentalism as the case for debtors’ prisons. As important as contractual rights are, they shouldn’t be sacrosanct in sovereign debt situations any more than they are in cases of individuals or companies. Moreover, there is no evidence that officials of debtor countries are disposed to renege on their obligations; if anything, the biggest problem with such countries is that they are too reluctant to seek debt relief. It is a well-established financial truth that serious debt problems, left unaddressed, almost invariably burgeon, so if losses are inevitable it is better to take them sooner rather than later. As a 2013 IMF paper noted, policymakers typically wait too long to face the reality that a country’s debt is unsustainable, and when they finally do, they don’t go far enough in addressing it. The result is that “debt restructurings have often been too little and too late.” This was one of the lessons of Argentina, where the impact of default was all the worse because of costly efforts to stave it off—and it was also one of the lessons of the Greek crisis.
Perhaps, as some argue, the Argentine case will turn out to be an isolated example of a country that got its just deserts in court for the way it stiffed creditors after its default. It’s true that the bondholder representatives who tried negotiating a settlement with Buenos Aires in the wake of the country’s collapse felt they were treated rudely, and the Argentine offer in 2005 was a take-it-or-leave it deal—with the explicit threat that holdouts would get nothing. So one possible consequence of this whole episode is that debtor countries will adopt more reasonable, less intransigent stances with their creditors, and mutually-satisfactory compromises will result.
But it would be Pollyannish to bet that events will take such a benign turn. After all, the most litigious bondholders cashed in big-time on Argentina, while non-litigious ones understandably feel they were played for suckers. Professional investors are not known for blithely forgoing chances to rake in enormous payoffs; this is why the odds have greatly increased that future Argentine and Greek-style crises will be even harder to resolve and more prolonged than they are already.
To anyone who isn’t 1) a wild-eyed zealot for bondholder rights, 2) a nostalgia buff for debtors’ prisons, or 3) an investor in a vulture fund, it should be clear that the international framework for sovereign debt is imbalanced way too far in favor of the Darts and Singers of the world, and against countries that genuinely need debt restructuring. The only question is the extent to which power should be rebalanced.
One heartening development is a 2014 initiative among financial industry leaders, governments and the IMF to promote the use of new types of bonds, called “Super CACs,” (the acronym stands for “collective action clause”). These bonds are legally fortified to force all of a country’s creditors into a restructuring if a heavy majority goes along. But Super CACs are no panacea, because global markets are still full of old-style, vulture-prone bonds.
Economists and legal experts have proposed an abundance of good ideas, ranging from the sensibly practical to the daringly ambitious. My favorite is the creation of a new type of IMF lending instrument called a “Sovereign Debt Adjustment Facility.” (SDAF), which would have some of the features of an international bankruptcy regime, and would deal with both the holdout problem and the “too little too late” problem. The IMF itself proposed a more far-reaching scheme in 2001, but it went nowhere.
Alas, the prospects for major reform of the SDAF type are bleak, not least because financial interests will marshall powerful opposition. So there may be no more need to cry for Argentina, but the shedding of tears may well be in order before long for a country in similarly dire straits.
Paul Blustein, a journalist and author, is a Senior Fellow at the Centre for International Governance Innovation. He spent most of his career at the Washington Post and Wall Street Journal. His books include And the Money Kept Rolling In (And Out): Wall Street, the IMF, and the Bankrupting of Argentina.