The Debt Frenzy

From Argentina to Zambia, investment firms are snatching up the poor world's debt. To turn a buck, they sue, harass, and otherwise claw their way into making debtor states pay. Poverty activists say these so-called vulture funds are preying on the impoverished. But they're only doing what the international financial system can't -- holding corrupt and irresponsible regimes to account.

BY DAVID BOSCO | JUNE 11, 2007

President Denis Sassou Nguesso of the Republic of the Congo likes to live large. In New York City for a series of U.N. meetings last year, he and his entourage holed up at the Waldorf Astoria hotel, where the president prefers to stay. When his party checked out six days later, their tab came to more than $100,000. Sassou Nguesso racked up more than $20,000 in room service charges alone for items including Cristal champagne. It was just the latest indulgence for the president of the impoverished central African nation, which has a per capita gross domestic product of around $1,700 and an average life expectancy of 54 years. In 2005, the president’'s Manhattan hotel bills exceeded $300,000.

Sassou Nguesso may not have anticipated that his profligate habits would be splashed across the pages of major Western newspapers, as they were earlier this year. But he shouldn't have been surprised. The president has acquired some resourceful adversaries, with good connections and a desire to expose official excess. Their motive? Congo owes them tens of millions of dollars.

Like most governments, Congo has at various times borrowed large sums of money from Western banks and investors. The transactions make sense in theory. The government gets cash it needs, and investors get a legally binding promise of regular interest payments. But like many other poor and mismanaged countries, Congo soon found that it couldn’t keep up with the payments. Prodded by activist-rock stars like Bono, many Western governments and multilateral institutions have forgiven billions in debt owed by poor countries. But even so, it is only a fraction of what poor governments like Congo owe. These governments must also pay billions to private investors and businesses, who are often far less charitable.

In the case of Congo, money is owed to Elliott Associates, a hedge fund whose specialties include collecting debts owed by governments. From its offices in Manhattan, Elliott has emerged as the chief debt collector to a host of governments. Colloquially, if somewhat invidiously, referred to as "vulture funds," Elliott and several similar hedge funds fight governments to ensure they pay what they owe. The countries that vulture funds chase down are usually poor and frequently corrupt -- Liberia, Nicaragua, Peru, Sierra Leone, Uganda, and Zambia, to name a few. Most vulture funds are based offshore and keep a low profile. One of the most aggressive fund managers is Kenneth Dart. He is heir to a Styrofoam cup fortune, lives in the Cayman Islands and rarely speaks to the media. Firms like his buy up the sovereign bonds and other debts of struggling countries, often at bargain basement prices. Then they do what most Western banks aren't inclined to do and what individual investors don’t know how to do: They sue, harass, and shame debtor governments into paying at least a chunk of what they owe. And they do well. In 1998, Peru paid Elliott more than $58 million for a debt the fund had bought for much less. Nicaragua has been ordered to pay more than $200 million. Just this year, Zambia was ordered to pay a British Virgin Islands-based vulture fund more than $15 million. In all, it is estimated that private creditors hold judgments in excess of $1 billion against some of the world's poorest countries.

CLAIMING THE HIGH GROUND

Unsurprisingly, vulture funds have become the favorite punching bags of the debt forgiveness movement. "These people are trading in human misery," spits one debt relief campaigner. Congo's Sassou Nguesso calls the vulture funds "snakes in the ocean" and "thug gangsters." The disdain for these debt collectors is shared in Western capitals, too. "By depleting the resources of developing countries' governments, these companies reduce the funds available for schooling and hospital treatment," declares a spokesman for Britain's treasury. Caroline Pearce of the Jubilee Debt Campaign believes that the vulture funds are misguided, even when their targets are middle-income countries that are better positioned to pay. "The way that vulture funds buy out very bad debt and seek to recover as much as possible is not helpful," she says.

Sitting in his understated office in midtown Manhattan, Jay Newman doesn't come across as socially irresponsible. A portfolio manager at Elliott Associates, he is slight and soft-spoken. But if Newman lacks Bono's volume, he can almost match him in righteous fervor. His contempt for governments that refuse to pay what they owe runs deep, as does his belief that vulture funds are a critical check on the "moral hazard" of debt default. Where the debt forgiveness activists see poor countries in need of relief, Newman sees corrupt, deadbeat countries "dragging our legal system down by disregarding the rule of law." Newman and his colleagues simply reject the idea that vulture funds are extracting money from the coffers of the poor. "Debt relief advocates should recognize that the beneficiaries of debt relief are often corrupt or incompetent regimes that squander their nations’ assets and then cry poverty to avoid legitimate debts," says an Elliott spokesperson. "This cycle must be broken for countries to achieve economic development."

There will always be countries that cannot pay their bills. Somehow, they and their creditors have to renegotiate the debt -- and history suggests that most investors are willing to compromise. In this atmosphere, vulture funds, which usually demand full payment on their bonds, can get in the way. Creditors that might otherwise be willing to accept 60 cents on the dollar may reconsider if a vulture fund can get full value. "It's like surrendering your seat on a crowded bus in favor of an elderly woman only to watch a teenager wearing a varsity wrestling jacket jump into it," notes Lee Buchheit, an attorney at Cleary Gottlieb, a law firm that represents many governments.

Such is the case with the vultures' biggest target yet -- Argentina. Hardly one of the world's poorest countries, Argentina is a self-confident Latin powerhouse with a booming economy. Its heated struggle with the vultures is being watched by investors around the world. The outcome will reverberate in global capital and financial markets and influence the behavior of dozens of other governments. Debt forgiveness may have captured the imagination of Hollywood activists, but debt collecting is still a critical part of how the world's financial system works, and Argentina is putting that part of the system to the test.

 

David Bosco is a contributing writer at Foreign Policy.