Felix Salmon

Daniel Davies has a spirited and intelligent attack on vulture funds, explaining why I’m misguided in my attempts to defend them.

He makes some good points, which I’ll come to in a second. And I do feel a little bit funny positioning myself as an apologist for vulture funds, many of which can be rather unpleasant and sleazy. My point is not (pace the Sunday Times piece) that in and of themselves they’re on the side of the angels. Rather, they’re a necessary and overly-maligned part of the international financial ecosystem, much like the birds after which they’re named.

For instance, is it really true that vulture funds are "the patent trolls of international debt, contributing nothing except aggro and making it much more difficult for larger and more responsible players to negotiate sensible debt workouts"? There are two problems with that view. The first is that large banks taking part in responsible debt negotiations are extremely happy to know that vultures are lurking in the background, willing to make life very difficult for the country in question if it doesn’t pay up. It’s pretty much the only negotiating leverage those banks have, since they’re never willing to go to court themselves: if we can’t come to an agreement with you, they essentially say, we’ll sell the debt to someone much less pleasant.

The second problem is that while those banks might well be larger than the vulture funds, they’re not obviously more responsible. The chair of Congo’s London Club creditors, for instance, was BNP – which also seemed to be the bank most involved in helping the family of the president to siphon off hundreds of millions of dollars of Congolese oil revenue into personal accounts held at you-know-where. In the world of international finance, banks regularly extend uneconomic loans to favored clients in return for getting business elsewhere; the same is true with sovereigns. So it’s not obvious why a commercial creditor with no ancillary business in the country should be happy to accept whatever sweetheart loan deal is negotiated by the banks. As for bilateral loans from rich countries to poor ones, those are nearly always made for geopolitical reasons – as are the subsequent loan write-offs. If France lent some African country millions of dollars to buy French arms, and then later wrote off the debt, it’s hard to see why a genuinely commercial creditor should simply accept the French precedent on the grounds that France is a "larger and more responsible player".

Now, are vulture funds genuinely commercial creditors? So long as you believe in being able to buy and sell debt obligations, yes they are. The Zambia case is actually exceptional here, since it involves debt which was originally bilateral rather than commercial. In the vast majority of vulture-fund cases, the debt is and always has been commercial, being extended originally either by banks or by companies doing business in the country in question. Take the hypothetical contractor who’s owed money for building a hospital: would you really force him to wait some unknown amount of time until the London Club finally got its act together, and then try to negotiate a deal with the foreign government on London Club terms? Or would you let him sell his debt for cash, to the highest bidder?

Davies’s main point, however, is different. He says that vultures are, essentially, "the unpleasant and unacceptable face of capitalism," to use a phrase memorably applied to another western capitalist doing business in Africa. He writes:

Do not think for one minute that people working for the Zambian government didn’t see this and immediately think "yep, that’s the way to get rich in Africa". I mean really, I have blogged at length on this one before, but if you were Levy Mwanawasa and you saw somebody walk off with $15m of Zambia’s money like that, what on earth incentive would you have to stint yourself on the Learjets and Ritz-Carltons? The big reason why people agree to debt relief is that an overhanging debt burden massively reduces the incentives to good governance, because all the rewards go into the pockets of overseas creditors.

The problem is that his argument was much more compelling two years ago, when he was writing about large national debt burdens, than it is today, when he’s writing about very small individual loans. If you owe ten-figure sums to banks and countries and MDBs, it’s easy to rationalize skimming off some of that money for yourself. But a single $15 million deal? Not so much.

In any case I am a big fan of debt relief, I think it’s one of the most effective ways to help a country which has a modicum of good governance – and as Davies quite rightly points out, it can in and of itself help to improve that governance. But a few million dollars of debt relief coming from a hedge fund? That’s going to make precious little difference either way. The big money comes from governments and multilateral development banks.

Davies continues:

We are all tebbly tebbly concerned about third world countries "maintaining their credibility in the capital markets" but there is also the important matter of said capital markets maintaining their credibility in the third world.

Which is an argument I’ve never made. A quick glance at pretty large economies like Nigeria and Argentina is all the proof you need that "credibility in the capital markets" is not exactly necessary for economic growth. The argument that "you’d better repay all your debts otherwise no one will lend to you any more and then you’ll be sorry" has never been particularly persuasive to me: it can make perfect sense for a government to compare the size of its current debt burden to the present value of its future borrowings (plus a little extra for the ease of doing business abroad), and to decide that it’s better off simply defaulting. The burden of proof is on the international capital markets to demonstrate how they can help these countries, given how unhelpful they’ve proven themselves to be during episodes like the Asian financial crises of 1997-8, or the Brazilian crisis of 2002.

Davies ends with this insight:

What the continent of Africa is full of, is chancers and get-rich-quick merchants. The natural resources industry is of course famous for such characters, and the trait that they share with vulture financiers is that they vastly prefer to substitute risk tolerance, sharp elbows and an eye for the main chance for graft and creativity. People like this are useful and even necessary in small doses, but (as any history of your favourite frontier and colonisation narrative will tell you), in large numbers they’re pestilential; a walking, talking infestation of the same kind of behaviour that’s the staple of the resource curse literature.

The idea is that people come in to mine a country’s stock of old debt much as they would its diamonds or gold. Except, they don’t, certainly not "in large numbers". Vulture funds are a rounding error when it comes to third-world debts; there are very few of them, and even fewer which are successful. In theory, I can envisage a world in which they were infesting African finance ministries in a pestilential manner. In practice, such behavior is very rare indeed, and, in the context of African debt politics more generally, largely irrelevant. Here’s a question for dsquared: except for Michael Sheehan, can you name anybody else who fits the description?

I missed this on Sunday – coincidentally, a day before Portfolio’s story about vulture funds came out – but Tony Allen-Mills has a very good article in the UK’s Sunday Times about the long-running fight between Elliott Associates and Congo-Brazzaville. He’s has a lot of sympathy with the vultures:

In the course of its near-decade-long pursuit of Congo, Elliott has probably done more than any other national or corporate entity to expose corruption in Africa. It has identified the middlemen who facilitate corrupt payments; it has traced the money trail from British oil traders to luxury boutiques in Paris.

Obviously my views are closer to those of the Sunday Times story than the Portfolio story. But make up your own mind: read them both, and see which one you consider to be more compelling.

Ooh boy. Condé Nast Portfolio, in its July issue, is running a major article about vulture funds by Joshua Hammer. Hammer certainly did a lot of reporting: he not only spoke to high-profile vulture investor Michael Sheehan, but even went to Zambia to get the other side of the story from the people Sheehan was suing.

Now this happens to be an issue I know a lot about; just last year I wrote a 5,500-word blog entry centering on the Sheehan-Zambia case. I’m also one of the few journalists to have had an extended sit-down interview with the other main subject of Hammer’s story, Paul Singer. I don’t know why Hammer never talked to me when he was reporting his story, maybe it’s because I write for Portfolio.com. Or maybe it’s because he’d already determined that he was going to vilify the vultures. But in any case, he ended up writing an incredibly one-sided article, and I really have to respond.

The tone of the article is set by its headline – "Vultures of Profit" – and the illustration of a particularly ugly bird flying off with its talons embedded in an Africa-shaped pile of money. The bird represents vulture funds, of course, which "are making ungodly amounts of money buying third-world debt on the cheap, then suing for the balance".

Before the article has even really started, it’s already making big mistakes. I don’t know what would count as "ungodly amounts of money" to the average reader of Condé Nast Portfolio, but by the standards of international finance and international debt markets in general, the amounts of money involved in these cases are actually tiny. As for the idea that vulture funds make money by suing, it’s one of those memes that simply refuses to die, despite the fact that it’s really not true.

The article starts off with Paul Singer, and the nicest thing it has to say about him is that he "is not the devil". But it’s not long before the rhetoric gets ratcheted up:

Vultures are currently tearing into several destitute countries… the vultures continue to feast… nefariously obtained… Singer and the other vultures are rapacious mercenaries, driven by an unconscionable greed that creates incalculable human suffering for millions… deeply immoral… there’s plenty of distressed debt out there waiting to be exploited… vultures can still take advantage of government malfeasance and a bribe-friendly environment… distressed debt that Slobodan Milosevic, the former Yugoslav president, allegedly gave to a crony as a wedding present.

Hammer is careful to ascribe many of these opinions to others, but the reader is left in no doubt where his sympathies lie. He quotes almost no one willing to defend vulture funds, and his recitations of their arguments are pro-forma and weak.

Aside from the rhetoric, it’s worth clearing up a few facts. For one thing, there’s a world of difference between getting a court judgment, on the one hand, and actually collecting on it, on the other. Hammer’s sidebar lists various funds which have won judgments against foreign countries, but neglects to mention how much, if anything, those funds have managed to collect. A bond, after all, is a legal document entitling the owner to a certain amount of money; so is a judgment. Converting a defaulted bond into a court judgment is hardly rocket science, and certainly isn’t the kind of thing which is going to make hedge funds tens of millions of dollars.

Note that it’s the smallest judgment on the list – $15.4 million to Donegal International – which is the only one that Hammer can convincingly show was actually paid by the country in question. So what, in reality, are these "ungodly amounts of money" that the article claims are being made by vulture funds? Well, there’s that one $15 million payment ($8.7 million in profit, after the cost of the debt and legal fees, after more than eight years of trying to get some value out of the debt), which stands in stark contrast to the $87.1 billion in debt which was eradicated as part of the campaign to wipe out the debts of heavily indebted poor countries, or HIPCs. Total payouts to vulture funds will probably never come close to even 1% of that number: these things are very marginal in terms of total capital flows and debt forgiveness for the countries in question.

And Hammer’s convinced that it’s all about the lawsuits. Singer, he says, is

part of a new generation of investors–the vultures–who buy up the defaulted debt of developing countries on the cheap, then sue to recover 10 or 15 times what they paid for the notes…They buy up the bad debt of a country for pennies on the dollar, then sue for payment in full.

One wonders how many of these vultures Hammer’s actually met, or whether perhaps when he did meet them he was so busy asking aggressive questions that he didn’t bother to stop and learn what they did. The very fact that he considers Singer to be part of a "new generation" of vulture investors would seem to imply that he didn’t: Singer, and his lieutenant Jay Newman, have been in this business pretty much as long as anybody.

It’s instructive to look at what Sheehan did in Zambia: first he donated $2 million of his debt to Zambia’s Presidential Housing Initiative in 1999. (It was at this point that Zambia waived its sovereign immunity, not in 2003 as Hammer asserts.)

Sheehan then tried to parlay the remainder of his debt into ownership of a Zambian lottery, or a local bank, or Kafue Textiles, or other parts of the Zambian privatization program. Eventually, when that didn’t work, he negotiated with the government and came to an agreement that the Zambians would pay about $14.5 million, or 33 cents on the dollar, over the course of 36 monthly installments beginning in 2003.

Even when Zambia defaulted on that agreement after just a few months, Sheehan still refrained from starting legal proceedings, instead attempting yet another round of negotiations with the Zambian government. It was only when those negotiations went nowhere that Sheehan embarked upon the only course of action still open to him: suing Zambia in London, many years after first acquiring the debt. Suing is not the aim of vulture funds; it’s their last resort.

It’s easy to see why that might be the case: since sovereign countries are sovereign, it’s almost impossible to force them to pay out on their debts if they’re not so inclined. But Hammer never mentions the enormous obstacles facing anybody seeking to sue a foreign country in a London or New York or Paris court, such as the legal doctrine of sovereign immunity. Instead, he mentions that "Britain is working to ensure that countries have access to legal advice to help them fight vulture fund suits," as though it’s the vultures, not the sovereigns, who have the natural upper hand in such cases. The fact is that legal advice is easy to come by for any sovereign who needs it: the main switchboard for Cleary Gottlieb in New York is (212) 225-2000.

So when Hammer writes that "Singer got into the game in 1996, when he bought $20.7 million of Peru’s debt for $11.4 million, then sued in U.S. District Court in New York for full repayment, plus interest," he’s being a bit misleading. Singer and Newman spent years trying to negotiate with Peru, and indeed were willing to settle at pretty much any time, the lawsuit notwithstanding. They knew that their chances of actually collecting were slim, and indeed they only did collect thanks largely to some fortuitous timing: their legal strategy finally came to a head just as Peruvian president Alberto Fujimori fled the country and his successor really didn’t need the extra headache of the debt problem.

And I have absolutely no idea what Hammer’s talking about when he says that Singer "persuaded a judge to declare him a preferred creditor, which forced Peru to repay him before meeting any of its other debt obligations". Preferred creditors, in the world of international finance, are multilateral institutions owned by states, such as the World Bank and the IMF. Even the US government isn’t a preferred creditor; there’s no way that Elliott Associates ever would be. And even if it were, preferred-creditor status has no legal enforceability; it’s simply a convention, which has been breached in the past and will be breached in the future.

Or consider this:

Between 1996 and 2001, Kensington went after the Congo Republic, a former French colony emerging from a devastating civil war… The World Bank reduced Congo’s debt by $2.9 billion in 2006, and many commercial creditors followed its lead. But Singer refused to get in line on Congo… Kensington sued in the British High Court for principal plus interest and won judgments of more than $100 million in 2002 and 2003.

The dates alone are confusing: if Singer’s refusal to act like other commercial creditors happened after the World Bank debt write-down in 2006, then why does Hammer say that Singer was going after Congo between 1996 and 2001? But more to the point, the London Club of commercial creditors only wrote down Congo’s debt in November 2007, five years after the events that Hammer is talking about.

Hammer’s attempt to explain where people on the other side of the argument are coming from is also weak:

The vultures are unapologetic; in fact, they claim they are the ones doing God’s work. Their argument goes something like this: Without vulture fund suits, primary debtholders would be left with worthless loans, the cost of borrowing would skyrocket for developing nations, and liquidity would dry up.

Well, that’s an argument, it’s not the main one. The main one is much more simple: debts are contracts, legally enforceable in a court of law. Without a contract, no one would ever lend any money to anybody else; if and when they did, the borrower could simply refuse to pay, with no negative repercussions. If people who own defaulted debt never sued for repayment, the entire basis upon which the multi-trillion-dollar debt markets are built would be undermined.

What’s weird about the whole article is that it appears in a business magazine, which normally celebrates the pursuit of profit. Yet in this case there’s no indication that hedge funds have any moral right to make money in the debt markets.

There’s an implicit assumption that whenever developing countries are concerned, the normal rules of capitalism should be suspended, and that poor countries should somehow try to get rich by bypassing simple concepts like the need to repay debts, instead relying on aid and debt forgiveness from the West, including from its hedge funds. But the fact is that no country has ever got rich that way, while the developing-world success stories are precisely those which have embraced capitalist principles.

So next time you see an article vilifying vulture funds, ask yourself whether these funds are really any more rapacious than any other hedge fund, and why they’re being singled out for opprobrium over profits of a few million dollars, rather than the multiple billions of dollars seen elsewhere in the hedge-fund universe. It wouldn’t be too hard to write a similar article about any number of other capitalists, but it’s always the vulture funds which seem to bear the brunt. No wonder they’re so shy about granting interviews.