Tuesday, July 29, 2014


One of the cable programs that I enjoy watching is Pawn Stars. The shop's co-owner, Rick, seems like a good guy who knows his stuff. It's also fun watching the experts come in to explain market values on everything from classic cars to classic toys.

I especially like watching when people come in with artwork or other artifacts they purchased or inherited. They often believe what they have is worth a small fortune, only to learn from the experts that what they have is worth only a fraction of what they want. Most accept the experts opinion. Others leave grumbling, saying that they will get the price they want (or paid).

But we all know, absent the appearance of a miracle or a sucker, they're really just talking to themselves. They won't get the price they want.

I bring this up because we are seeing the functional equivalent of Pawn Stars' disappointed and delusional clients played out at the international level. Only this time, instead of Rick, we have Argentina telling grumbling creditor-clients that they need to accept new market prices, which were established in 2005 and 2010 when 90 percent of Argentina's creditor-clients renegotiated what was owed to them.

Here's how it happened.

When Argentina experienced a political crisis in 2001 and 2002 banks and other financial institutions who had lent Argentina money in the 1980s and 1990s (and earlier) became worried. Many believed that Argentina could no longer pay what they owed and decided to sell their debt contracts.

Many debt contracts were sold in a fire sale for pennies on the dollar, with the sellers effectively telling the buyers, "Good Luck."

While 93 percent of Argentina's creditor-clients accepted the result of the negotiations, and new prices, a small group of holdouts who had purchased Argentinian debt contracts (again, for pennies on the dollar) did not. They want to be paid the full value of the debt contracts they purchased, and have dug in their heals.

They are also considered "vulture capitalists" because of how they are preying on distressed debt.

So, for example, a $100 million Argentinian debt contract might have been discounted and sold for $35 million. But the new buyers want $100 million. If we're thinking about Pawn Stars, it would be as if someone bought or inherited a classic piece of valuable art that suddenly dropped in price. They then enter Rick's pawn shop to demand that Rick pay them what the art piece was once worth.

What do you think Rick is going to say?

Unfortunately for Argentina things aren't so cut and dry in international financial markets. When Vulture Capitalists purchase and hold contracts that are worth more than what they paid they can use both political pressure and the courts to press their case. It doesn't matter that Argentina negotiated new debt contracts in 2005 and 2010, which established a new "market" price (interest and terms were renegotiated too). With politicians and the courts working for them Vulture Capitalists believe they are entitled to the full value of the contract.

While Argentina did not agree to pay 100 cents on the dollar they did agree to pay more than the pennies on the dollar the Vulture Capitalists paid. You would think that this would have been good news for the Vulture Capitalists, right? Not so fast.

The new creditors want to be paid the full value of the contract. And they're threatening to force Argentina into default this week if they don't get their way.

This is where it gets interesting, and why additional history is warranted.

After Argentina went through economic turmoil in 2001 and 2002 - a period that was called the worst in its history - Argentina's debt as a percentage of GDP rose to 166 percent. Worse, the political gains made in the 1990s, after decades of military rule, were very much in danger. Argentina's President Fernando de la Rua (now on trial) even had to flee the presidential palace on a helicopter after riots escalated.

Everyone understood the stakes involved.

After much hand wringing and negotiations, Argentina and its debt holders agreed to restructure their debt contracts. This was no easy feat, and took years (2005 and 2010). The new terms gave Argentina some breathing room, which has enabled the country to pay its international obligations on time ever since. The nation's debt as a percentage of GDP now stands at about 45% (for comparison, U.S. debt to GDP stands at 103%)

Over 90 percent of Argentina's creditors - which included U.S.-based unions, pension and retirement funds -  agreed to accept the new reduced terms. So, for example, instead of getting a 15 percent interest rate of return creditors might get 10 percent. This was considered better than the alternative, which included non-payment, or outright default.

Again, this was an agreement that over 90 percent of Argentina's bondholders accepted.

Those who accepted the new terms understood that you cannot drive debtors into a corner (think Wiemar Germany). They wisely understood that an Argentinian political and economic meltdown could do damage that would reverberate throughout the region, and the global economy.

Unfortunately, this is not the case with 7% of Argentina's bondholders, who are known as Vulture Capitalists. They don't care that they didn't actually lend Argentina money. They don't care that they purchased the contracts for pennies on the dollar. And they don't care that the only reason Argentina is in a position to pay back their debts today is because other creditors sacrificed and renegotiated.

Their only goal is to strip Argentina's economic carcass, regardless of the political and economic consequences it could have down the road.

Let's recap.

The market players who paid pennies on the dollar - and who work for Vulture Capitalist firms - are demanding that Argentina pay them the full value of their contracts. These firms never lent Argentina money. The firms simply purchased discounted debt contracts, many of which originated when Argentina was run by the a brutal and corrupt military dictatorship.

Worse, the Vulture Capitalists want Argentina to pay them before they pay those who agreed to restructure Argentina's debt, and those who are currently lending Argentina money.

To get satisfaction the Vulture Funds have taken their case to court in the U.S. Incredibly a New York district judge has sided with the Vulture Capitalists, awarding two firms $1.3 billion. Stating that 'judgments are judgments' U.S. District Judge Thomas Griesa is effectively elevating the rights of those who purchased Argentina's debt for pennies on the dollar over those who worked with Argentina, and helped the country avoid civil unrest.

Going back to our Pawn Stars example above, can you imagine the owner of a classic car going to Rick's pawn shop and telling him that if he doesn't get his $100,000 asking price that he'll sue him in court for the money? Can you imagine a court taking the car owners side?

Right about now, I'm sure, there's probably a few readers yelling at the screen something about the "sanctity of contracts." All I have to say is grow up. This kind of thinking is based on a flawed understanding of how the world really works.

Here's what you need to know.

1. SANCTITY OF CONTRACTS?: Union contracts regularly get busted or renegotiated during periods of stress. Just ask Detroit's auto workers, airline pilots, etc.
2. THE FINE PRINT: Private corporations, especially credit card companies, regularly play "fine print" games with their contracts, jacking up rates for no other reason than they can.
3. DISTRESSED DEBT OFTEN RENEGOTIATED: Bankruptcy judges in the U.S. regularly write down mortgages for commercial property, and other secured loans (just ask Donald Trump).
4. CONTRACTS-AGREEMENTS REGULARLY IGNORED: Many states - like California - backed out of contractually agreed upon raises after the 2008 market collapse. California even docked state employees 10 percent of their contracted wages to deal with the impact of the 2008 market collapse.
5. HIDING BEHIND BANKRUPTCY: Corporations and their subsidiaries regularly close up shop, file for bankruptcy, and ignore legal and other contractual obligations when they want to avoid legal obligations (like this one in West Virginia). 

There's more, but you get the point. In effect, market players who purchased distressed debt for pennies on the dollar knew - or should have known - what they were getting into. The sanctity of contracts is not carved in stone.

The Vulture Funds at the center of this dispute are lucky Argentina is in the position they are today. Simply, put, if things had gotten out of hand and others had not stepped up to the plate to renegotiate, the Vulture Funds wouldn't have a pot to piss in today.

Here's my take on the issue.

First, the market players who are holding out for full payout knew they were taking a big risk when they purchased Argentina's distressed debt. They knew that Argentina was in the process of renegotiating it's debt. They knew that dealing with a country is different than dealing with individual creditors in a domestic market. What the Vulture Funds are doing today, as they deploy the U.S. court system to do their dirty work, is simply mooching off of the blood and sacrifices of Argentina and the financial players who stepped up to the plate to renegotiate and help Argentina avoid political turmoil.

Second, what Argentina did when it renegotiated its debt was effectively go through a bankruptcy escorted debt restructuring. The difference is that it was done at the level of the nation-state. As a result of debt restructuring Argentina was able to put in place a new debt management strategy, which has benefited all of Argentina's debt holders over the past 10 years.

Using the courts to vacate the renegotiated contracts, and to get to the head of the payment line, is just wrong. What the Vulture Funds are doing today makes it clear that there are a group of market players (they're not investors) who don't care for the rules or the sanctity of the market.

Worse, they believe the institutions of the state are here to guarantee their market bets. Think about it.

As the Vulture Capitalists balk at paying U.S. taxes they regularly use U.S. government courts, to try and manipulate a U.S. government structured international trading regime, to get a sovereign government to pay them in government backed currencies. Vulture Capitalists are simply acting as corporate free riders.

Finally, as Argentina's President Cristina Fernandez de Kirchner never tires of pointing out, Argentina has never repudiated its debt. It simply renegotiated debt terms, as market players often do.

Argentina's President Cristina Fernandez de Kirchner

Anyone in the U.S. who has gone through bankruptcy restructuring understand what this means (again, see Donald Trump). Using the U.S. court system to enforce distressed contracts at full value makes a mockery of our markets, and subsidizes people who are gambling rather than investing. Where's the risk if U.S. courts are going to step in to guarantee your returns? (The point here is that there is no free market if this is your business strategy.)

If the Vulture Funds win the day this will send a terrible message to creditors and sovereign nations alike. No sensible creditor will want to renegotiate if they believe that their renegotiated flow of payments can be disrupted by Vulture Capitalists, who get to jump to the front of the line after someone else has done all the hard work of making a nation whole again.

At the end of the day, when it comes to Argentina, the Vulture Capitalists are little more than wealth extractors rather than wealth creators. They would rather feast alone on an economic carcass than dine with their peers at an economic buffet.

Argentina needs to take a hard line when their deadline to pay the Vulture Capitalists arrives this Thursday.

- Mark

UPDATE (Aug. 1, 2014): It appears that Argentina has chosen to default on what it owes the Vulture Funds, and that's a good thing. Click here for information on billionaire Paul Singer, of the hedge fund Elliot Management, who has helped push Argentina into default. According to Vice News, after paying about $48.7 million for distressed debt Singer's firm is demanding that $832 million be paid (a return of 1,608 percent), with the rest of the Vulture Funds demanding a total of $1.3 billion. The NY Times' DealB%k has additional history and commentary here or here.

UPDATE II (August 9, 2014): Getting personal? Judge Griesa is not happy with Argentina's response to this orders. He's threatening Argentina with contempt of court over statements Argentina has made about their debt and his claim that they defaulted on that that. Check it out here in the NY Times.

UPDATE III (April 1, 2015): The plot thickens ... Argentina ousts local Citibank CEO for complying with U.S. court order, while ignoring Argentina's local laws regarding the restructuring of debt.

UPDATE IV (June 6, 2015): Argentina is going to appeal yesterday's decision by U.S. District Court Judge Thomas Griesa to side with the creditors. Argentina is referring to the decision as 'illegal' and 'unfortunate.'

UPDATE V (March 11, 2016): Argentina's new right-wing president, Mauricio Macri, agrees to pay $4.65 billion to four hedge funds, or about 75 percent what they were demanding. Vulture fund speculator Paul Singer nets about $2.4 billion, or 10-15 times his original investment. You can watch a YouTube video report of the deal here (893).

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