Vulture capitalists buy up distressed debt at a fraction of the face value then use whatever means they can find to extort the debtors to pay the full face value. The debtors have already settled on payment terms with creditors under the applicable legal standards, and are generally acting in good faith and honoring the restructured debts. Such is the case with Argentina, which defaulted on about $100 billion in debt in 2001. in 2012 U.S. District Judge in New York Thomas Griesa contorted law and reason to issue a ruling that required Argentina to pay the vultures at Aurelius Capital Management LP and NLM Capital full face value on bonds they bought from a creditor at a fraction of that price. This week, the US Supreme Court ignored pleas from the US Treasury, The US and French Governments and the IMF to overturn the case, and refused to hear Argentina's appeal of the case. As you might imagine, the implications for any other nations who have or hope to restructure their international debts are devastating.
I'm not really an expert on the subject, and I was a bit surprised that my search for diaries on this subject turned up nothing, so I'm just going to mostly paste things that I found on NakedCapitalism.com into this diary. All the facts and intelligent sounding details come from those who know what they're talking about. Most of the expletives end easy parts will be mine. The executive summary is that the courts have not only tried to fuck Argentina, but may have also threatened many existing and future debt restructuring deals. Fortunately, it seems like Argentina and Christina Kirchner are not going to roll over. Consider the precedent, and consider the system.
Investors buy sovereign debt (bonds) from countries because they get paid interest. The interest is determined by the market's estimation of the risk of that nation defaulting on its debt or devaluing its currency (if the bonds are so denominated), or otherwise reducing the capital invested. That is the point. Interest balances risk. Now a crazed judge and corrupt SCOTUS are saying essentially that even after a restructuring has been agreed to by debtor and creditor, a 3rd party can buy the cheap restructured bonds and demand the full value of the bonds PLUS INTEREST. WTF? If you remove the risk but keep the interest, you are basically playing another 'Heads I win , tails you lose scam'. Doing that years after the fact is worse. Now what incentive will any creditor have for ever settling for less than full face value from defaulting nations?
My mind turns to Greece, not only because they are a potential poster child for sovereign default, but because their membership in the Euro has already provided a sort of de facto guarantee against losses to bond holders. Moreover, this EU backstop for Greek sovereign debt was not only entirely foreseeable, but was foreseen by the banksters who helped Greece hide its debts to get into the Euro in the first place. After that, they could just load Greece up with debt, collect interest, and know that their risk was eliminated, since a sovereign default within the EU currency union would not be permitted. In essence, they could hold the entire Euro world hostage to cover their bets.
It may sound like something out of the Sopranos, but they were small-time punters in comparison to Goldman Sachs, who ran the initial scam with the conservative Greek government, and now serve as the technocrats protecting the Euro by covering the banks' bets while squeezing the citizenry.
Enough of the rant, lets get some juicy blockquotes on, first from a NakedCapitalism piece on the judgement:
The case has its origins in the 1990s, when the government of Carlos Menem fixed the Argentine peso at the value of one U.S. dollar
...
an unsustainable strategy, which exploded in a financial crisis in 2001, bringing on a major devaluation of the currency and a default on around $100 billion of external debt.
In 2005, the government of Nestor Kirchner, which had then managed to revive the economy to some extent, offered its creditors debt swaps that significantly restructured the debts.
...
93 per cent of government bonds participated in the debt swaps of 2005 and 2010.
However, a tiny minority of creditors held out and refused to accept the negotiated settlement. These then sold their holdings to hedge funds (in this case known as “vulture funds” that take on distressed assets in the hope of recouping a higher value from them). One of the most prominent of these funds in the Argentine case is NML Capital, a subsidiary of Elliot Capital Management, which is run by U.S. billionaire and major Republican party donor Paul Singer. This fund has a history of using aggressive tactics to force struggling sovereign debtors to pay the full value of debts that have already been deeply discounted by the market. In the past, it has successfully sued the governments of Peru and the Democratic Republic of the Congo.
Ever since it bought Argentine bonds at around 20 per cent of the face value in 2008, it has been pursuing the case both legally and physically. In 2012, it hired mercenaries to detain and try to seize an Argentine ship where it was docked off the coast of Ghana; at another time it even attempted to grab the Argentina Presidential plane from an airport—as “collateral” for its supposed holding of debt. Legally, NML Capital and another vulture fund, Aurelius Capital Management LP, have been pursuing a case in a New York district court, demanding full payment on their debt, of the value of around $1.5 billion. It has been estimated by the Argentine government that this could amount to a return of more than 1600 per cent on the initial investment made by these vulture funds.
Consider just some elements of this U.S. court decision. First, it is based on a peculiar and unprecedented interpretation of the pari passu (equal treatment) clause, which holds that all bond holders must be treated alike. The courts have interpreted this to mean that a sovereign debtor must make full payment on a defaulted claim if it makes any payments on restructured bonds.
So the boilerplate
pari passu clause has received an unprecedented new interpretation that lets even a single holdout creditor scuttle an entire restructuring. But that is not all. The court also held that any intermediary banks assisting Argentina may be held in contempt, and may be compelled to divulge all information about Argentina's assets worldwide, in violation of US and international banking secrecy laws. So a rogue US judge is playing matches in the tinderbox of international finance, sweeping aside precedent and reason in a way that could make the Hobby Lobby debacle look limited and harmless.
Ruth Bader Ginsburg was moved to ask “By what authorization does a court in the United States become a ‘clearinghouse for information’ about any and all property held by Argentina abroad?”
From Martin Wolf at the Financial Times:
As the IMF recently noted, these clauses “typically only bind holders of the same issuance”. A holdout creditor can “neutralise the operation of such clauses” if they secure a blocking position, normally more than 25 per cent.
Moreover, adds the IMF, US courts have interpreted a “boiler plate provision” of these contracts (the so-called pari passu clause) as requiring a sovereign debtor to make full payment on a defaulted claim if it makes any payments on restructured bonds. In addition, the US courts will force financial intermediaries to help creditors obtain hold of the sovereign’s assets. All this will make restructurings harder. Why should creditors accept an exchange for instruments with reduced value in future?
...
This is extortion backed by the US judiciary.
In an
interview with Real News Network, James S. Henry Senior Economist at the Tax Justice Network pointed out:
Basically, we have no mechanism for handling country debt the way we do for private sector bankruptcy. And the IMF tried to suggest a system back in the early 2000s. The world just didn't go for it. As a result, we have this cockamamie system where a New York judge is making rulings based on sort of 19th century concepts of contract law. And he only has jurisdiction in this case because Argentina is one of four Latin American countries--unlike Brazil--that has decided to choose the Southern District of New York, one of the Wall Street safe havens in terms of the federal judiciary, as the location for ruling on all of these cases with respect to Argentine foreign debt.
It has a history of ruling against debtor countries. It's totally repealed the doctrine of champerty, which is a doctrine of the law that says that you can't go out and buy somebody's debts up and then just take them to court and sue just because you've become a creditor. But the judges in the Southern District of New York tossed that out in the late '90s. And this is one of a series of vulture cases where companies like Elliott have been going around the world, countries like Panama and Nicaragua and Peru, and basically leveraging the fact that they have friendly judges in the Southern District of New York like Judge Griesa.
...
As of 1976, Argentina had a total foreign debt of $18 million, 17 percent of GDP. The military came in in '76 with U.S. government support, established a junta. By 1983, the debt had soared to $48 billion--by a factor of seven. And no one has ever audited that debt. There's--and, interestingly, there's a U.S. legal doctrine called odious debt which says that if you have a debt that's contracted by a military dictatorship, it doesn't necessarily have to be honored. We invoked it with respect to Cuba in 1898. It had acquired a lot of loans from Spain, and nobody could account for where they were. But this odious debt doctrine had never been applied to Argentina.
Interestingly, the other thing is that this choice of jurisdiction was originally chosen by this military junta back in 1976. Martínez de Hoz, the finance minister at that point in time, a very conservative guy, decided that Argentina would waive its sovereign immunity for purposes of all this debt that it was beginning to accumulate and allow the United States and the Southern District of New York to be the situs for all of these cases. So those two very fundamental changes made by, essentially, a military government, first of all blowing up the debt out of proportion, and then relocating the judiciary outside of Argentina, is very important for what we're seeing all the way forward to 2014.
So Argentina may be forced into default by a US judge and a couple hedge funds. It looks like they will not simply pay off the extortionists, though the deadline is set for July 31 2014.
The President of Argentina, Dr. Christina Kirchner Had this to say:
It’s definitely NOT ‘default’ by any stretch of the imagination.
It’ll have to be something else, something new.
I do know that experts, investment banks, and academic gurus are always struggling to find new terms to disguise what is really happening.
In this case it will have to reflect the fact that a debtor has payed punctually (as usual), but in this particular case someone has decided to block such payment and does not allow the money to be received by a creditor who entered into a restructuring agreement in good faith. Both debtor and creditor are being robbed.
So it may not be as easy to shakedown a country with South America's third largest economy and a strong, reasonably progressive leader as it was with, say, the Democratic Republic of Congo.
It is a distinct possibility that the vultures are prepared for, or even hoping for this outcome because they have covered these debts with credit default swaps (you may recall the CDS as a major element in the Jenga tower of the shadow banking system that brought the financial world to its knees in 2008). If that is the case, then we can look to the usual TBTF suspects as the counter-parties to these swaps. The already over-leveraged banks will suddenly have to pony up billions. An event like that could well become contagious, leaving the usual marks (that's us) on the hook for more bailouts of systemically critical institutes of plunder and extortion.