“Who’s always eager to extend a friendly claw?” In The Jungle Book, a quartet of mischievous vultures befriends Mowgli, the orphan protagonist of the classic children’s tale. The vultures endearingly court the boy, first asking him “when you’re lost, in dire need, who’s at your side?” before sinisterly reassuring him that they are his “friends to the bitter end.” Beyond the jungle’s frontiers, vultures who speak the legalese of financial civilization’s leather-seated boardrooms are every bit as cunning. So-called vulture funds—private equity or hedge funds that buy the distressed debt of developing countries at rock-bottom prices with the hopes of profiting through litigation rather than through market forces—have recently become the bane of Argentina’s economic future.
Litigation from holdout creditors has endured for more than a decade, ever since Argentina defaulted on about $100 billion of its debt in 2002. Vulture funds, led by Elliot Management Corporation’s NML Capital, recently won the right to be paid in full—a tally reaching about $1.6 billion—after the United States Supreme Court declined to review Judge Thomas Griesa’s earlier district court ruling, which was issued last month. The Argentine government now has until Wednesday, July 30th, to pay these dues. If it does not, it will officially default for the second time in 12 years. Linking its legal pursuit of Argentine assets to local corruption scandals, NML Capital has portrayed itself as a friend to the bitter end, claiming it has a “common interest with the Argentine people in identifying and recovering stolen state funds.” Its legal actions, however, could end up doing irrecoverable harm to both the Argentine people and to the international financial system.
Unlike firms and individuals, sovereign nations do not have any orderly legal bankruptcy proceedings to turn to when mired with excessive debts. Notwithstanding its stigma, bankruptcy’s silver lining for debt-ridden companies and individuals is that it compels full creditor participation by legally requiring holdout creditors to accept negotiated settlements. In lieu of such legal protections internationally, sovereign nations must rely on decentralized creditor negotiations. This, however, allows some bondholders to refuse to participate in debt restructurings.
Ninety-three percent of Argentina’s creditors accepted new terms for the country’s bonds in 2005 and 2010. NML Capital and other holdouts did not accept these restructuring deals. To overcome this problem of coordination, national governments have developed collective action clauses that force holdouts to accept settlements that have been negotiated by a majority of creditors. These clauses in sovereign bond contracts, however, are a recent phenomenon, and were not included in bonds issued prior to Argentina’s 2001 crisis.
In the absence of a suitable bankruptcy framework, the Argentine government has, until recently, done little to improve its debtor status internationally. Shut out of global capital markets, the Argentine government has flubbed its nose at global capitalism, renationalizing the state-oil company YPF in 2012, doctoring its official inflation statistics, and engaging in heavy trade protectionism.
But the vulture funds are bathing in even murkier waters. Although not themselves the original lenders to the Argentine government—and thus not the only creditors at the side of a nation in dire need—they have exploited a lack of bankruptcy law to profit internationally. Building on a precedent set by holdout creditors of Peruvian debt in 1996, Argentina’s vulture funds bought up distressed debt in secondary markets and rejected the restructuring accepted by the vast majority of creditors to instead reap gains through litigation.
In light of these actions, the Argentine government is left with only unenviable options before tomorrow’s deadline. With negotiations for a settlement at an impasse, it faces a debate between two evils. On the one hand, the country could simply decide to pay its holdout creditors. With reserves tallying about $29 billion, Argentina could easily afford the $1.6 billion price tag of a settlement with NML Capital and its affiliated holdouts. The problem, however, lies in the potential cascade-effect that could result from this decision. The Argentine government has estimated that claims from other bondholders demanding similar terms as the current holdout vulture funds could surpass $15 billion. If Argentina decides to simply pay its debts, having to do the same in such similar cases could seriously deplete the nation’s reserve funds meant to protect against future financial instability.
This option is also less politically palatable for Argentine President Cristina Kirchner. Kirchner, currently in her second term, has previously refused to pay the holdouts, lambasting them for “attacking Argentina so that we go back to the 90’s financial looting.” Moreover, despite her sagging political popularity, Kirchner’s political stance against vulture funds has played well domestically. A recent poll by Poliarquía Consultores found that 47 percent of Argentines view Kirchner’s aggressive rhetoric toward the hedge funds positively, up from 38 percent a month ago.
Argentina’s second option is for the Kirchner administration to refuse to pay its debts prior to Wednesday’s deadline. However, despite the potential political fallout, the country would be in a far worse economic position if it were to default. It has spent considerable financial resources attempting to repair its image with international creditors. These efforts have included repaying its $10 billion in arrears with the Paris Club of creditor nations and delivering about $5 billion in compensation to Repsol, a Spanish energy company, for the Argentine government’s expropriation of YPF, the country’s main oil company. A default would crush Argentina’s hopes of returning to global capital markets, a severe blow for a cash-starved government in desperate need of international credit to revive its fledgling economy.
The prospect of default not only threatens considerable implications for Argentina’s welfare but also for the functionality of the international financial system. If a few holdout creditors are shown to be able to bypass existing settlements negotiated with the rest of a country’s bondholders, future debt restructurings could be far more arduous for other developing nations. The inability of creditors and debtors to reach an orderly debt resolution in times of crisis could intensify capital flight and funding shocks for countries already struggling to pay their debts, making economic recoveries far more difficult. In today’s globalized world, financial crises may well be inherent to the decentralized nature of the worldwide economic system. There is no reason, however, that their resolution should be left to the laws of the jungle.