Putting Vulture Funds in Perspective

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?