VULTURE FUNDS?This new painting by Christopher Page, exhibited at Gallery 118 this month, was snapped up on the opening night by an eager collector. Its hard predatory eye and watchful sense of absolute entitlement mark the creature out as an apt symbol of a new kind of finance. What exactly are 'vulture funds', who are the men who operate them, who benefits, and who falls by the wayside?
As the name suggests, these funds are metaphorically vultures patiently circling, waiting to pick over the remains of a rapidly weakening company or, in the case of sovereign debt, debtor. Market practitioners prefer to refer to them as distressed debt or special situations funds.
Vulture funds focused on debt target not only corporate obligers, but also sovereign debtor states. In the recent case of Argentina, for example, vulture funds bought up a significant portion of the country's external public debt at very low prices (sometimes only 20% of their nominal value), and then attempted to cash them when the Argentine economic crisis exploded in 2002. A single vulture fund run by Kenneth B. Dart, heir to the Dart Container fortune, claimed 700 million USD in a lawsuit against the government of Argentina. It should be noted, however, that Argentina itself was behind many of the secondary market purchases. Some estimate that in the debt exchange of 2005, Argentina controlled over half of the debt tendered.
Vulture funds have sometimes had success in bringing attachment and recovery actions against sovereign debtor governments, usually settling with them before actually realizing the attachments in forced sales. In one instance involving Peru, such a seizure threatened payments to other creditors of the sovereign obliger. Settlements typically are made at a discount in hard or local currency or in the form of new debt issuance. A related term is "vulture investing", where certain stocks in near bankrupt companies are purchased upon anticipation of asset divestiture or successful reorganization. A prime example in the U.S. is K-Mart, where the real estate held by the company was the anticipated payout for investors who bought stock during their bankruptcy proceedings.
History
Sovereign debt collection was rare until the 1950's when sovereign immunity of government issuers was restricted. This trend developed due to the long history of sovereigns defaulting on commercial creditors with impunity. Accordingly sovereign debt collection actions began in the 1950's. One example was the freezing of Brazil's gold reserves held by the Federal Reserve.
Investment in sovereign debt with the intent to recover was also restricted due to the laws of champerty and maintenance and by the fact that most sovereign debt was syndicated. Under the doctrine of champerty, it was illegal in England and the United States to purchase a debt with the sole intent of litigating it. The disctinction was made that if the debt was purchased to effect a recovery or facilitate investment, the doctrine was not a bar. Most jurisdictions have now eliminated the doctrine as archaic.
Similarly, sovereign debt owed to commercial creditors in the late 1980's was principally held by bank syndicates. This was the result of the petro-dollar crisis of the 1970's when oil earnings were recycled into bank loans. The syndication of debt among banks made recovery impractical as a fund intending to litigate had to buy out the entire syndicate of holders or risk having the proceeds of litigation attached pursuant to sharing clauses in the loan agreements.
As the 1980's progressed debt rescheduling efforts in Latin America created many new and easily traded instruments such as Brady bonds that brought new players into the market including banks and hedge funds. The original creditors then wrote down their positions and sold the debt into the secondary market, a market consisting of banks and investment funds focused on buying at discounts to achieve above market returns on their investment.
In this process much debt was repurchased and converted into local currency by the sovereign country issuers in official debt conversion programs designed to attract investment and in severely indebted countries through World Bank funded buy-backs. The result is that the old syndicates were broken up and many unrestructured syndicate "tails" were available for purchase at discounts exceeding 80% of principal face value. That pricing encouraged funds to invest in recovery actions which would not otherwise make financial sense due to their length and cost.
Godfrey Old, a disturbing and thoroughly entertaining amalgam of Chaplin, Marcel Marceau and Max Wall: the Mad Hatter in Leftovers' production of Alice, Pentameters Theatre, Hampstead, Monday 23 March - Saturday 4 April 2009. Tel: 0207 435 3648
