– Aggressive creditors and investors are seriously undermining the ability of poor countries to deal sustainably with debt issues, academics and anti-poverty campaigners told a briefing at the U.S. Capitol on Wednesday.
Further, many of these investors are now based in the United States, after other important financial centres have moved to curtail such practices. As such, national lawmakers and international experts are stepping up calls for Washington both to follow suit domestically and to lead a related international effort.
“We need to acknowledge that aspects of the financial crisis could have been prevented if we had basic, common-sense principles on responsible lending and borrowing within the international financial system,” said Eric LeCompte, executive director of Jubilee USA, a network of anti-debt campaigners and a co-host of Wednesday’s briefing.
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“In fact, both Northern and Southern countries that have gone through severe external debt crisis may have been saved the severe shocks to their economies and austerity restructuring if these reasonable principles were in place.”
(Jubilee released a full report on these proposed principles last year.)
Maxine Waters, a member of the House of Representatives, agreed, saying in a statement, “The time has come for the world to design a formal, more efficient system for managing the restructuring of sovereign debt.”
At issue is a strategy adopted by a small number of hedge funds to purchase reduced-rate debt from poor countries with little hope of repayment. These firms then file lawsuits against those governments for failure to repay, looking to scoop up government revenues and international aid monies when they eventually start to flow.
Perniciously, these firms maintain the lawsuits even as other investors typically agree to reduce some debts, accepting lower-than-expected returns that nonetheless allow the indebted government to begin to recover. Even a single such “holdout creditor” (also known as a “vulture fund”, for having purposefully sought out governments in fiscal distress) can gum up the entire debt-restructuring process.
“One of the most obvious remedies being discussed is that of collective action clauses, which allow a super-majority of creditors to force holdouts to accept a restructuring,” Rep. Waters noted Wednesday.
“Yet it would be wrong to rely solely on such clauses … This is why I favour the establishment of a formal, institutionalised, and politically recognised mechanism for restructuring the debt of bankrupt sovereigns, which would address all forms of debt.”
Other countries, most notably the United Kingdom, have already put in place restrictions aimed at undercutting the motivation to engage in such “vulture” speculation. Yet the United States has yet to do so.
On Wednesday, Cephas Lumina, the United Nations independent expert on the effects of foreign debt, noted that the U.S. is today a “preferred jurisdiction” for holdout creditors. He called on Washington to take “robust legislative measures … to limit the ability of vulture funds to pursue immoral profits at the expense of the poor.”
In the aftermath of the 2008-09 financial crisis, government debt has become an increasingly important topic for all countries. And as austerity measures increasingly impact on poor communities, some advocates suggest that stronger international principles on sustainable lending practices could mitigate some of these ongoing ramifications.
Perhaps improbably, the issue of holdout creditors has heated up considerably here in Washington in recent months. Much of this is due to a landmark legal fight taking place between the government of Argentina and two New York-based hedge funds – NML Capital and Aurelius – that own some of the bonds Buenos Aires, then facing bankruptcy, defaulted on in 2001.
In a widely watched decision, in August a judge ordered the Argentine government to pay the two funds nearly 1.5 billion dollars. But Buenos Aires rejected the decision, saying that it would continue to repay its debts on its own terms (indeed, it is barred from paying the hedge funds, due to a law passed by the Argentine legislature in 2005).
It also warned that agreeing to pay off NML and Aurelius would embolden the 93 percent of Argentina’s other creditors – each of which has agreed to accept lower repayment – to demand their full share. Doing so, Argentina noted, would put the government back in the situation it faced in 2001.
The case has now been appealed to the U.S. Supreme Court. Although the justices refused to take on the issue in October, following a new appeal many observers now see a high probability the court will review the case.
Jubilee’s LeCompte says the stakes are high. Most countries facing holdout creditors, it should be noted, are far poorer than Argentina.
“The outcome could have some of the most far-reaching consequences for global poverty in our lifetimes,” he says.
“If the hedge funds win, they will have a precedent that will allow them to dismantle 15 years of core U.S. debt restructuring policy. With this precedent, the hedge funds will hurt some of the most fragile economies in the world.”
In June, even the International Monetary Fund was planning to file a brief on behalf of Argentina with the U.S. Supreme Court, its first ever such move. That decision was scuttled, however, reportedly due to lack of support from the U.S. government.
Some see the issue’s suddenly high visibility as encouraging for potential legislative action.
“It would certainly be good timing right now, so we’ll probably see something rolling out,” Nathan Coplin, coordinator of the New Rules for Global Finance Coalition, a Washington-based international network of activists and researchers, told IPS.
“This will have a major precedent for sovereign debt for middle income and low-income countries. But there could also be an impact for the United States – given that one holdout creditor can stall the entire [restructuring] process, countries may consider issuing their bonds outside the U.S.”
It is currently unclear how much appetite there is in the U.S. Congress to tighten regulations on holdout creditors. Representative Waters has repeatedly introduced legislation to do so in past years, but none of these proposals was even brought up for a full vote.
Still, despite the significant lobbying power of the U.S. financial services industry, most investors don’t want to have anything to do with “vulture funds”.
“Certainly legitimate investors are in support of having a streamlined process, in which they can restructure the debt and move on,” Coplin says. “Where exactly the pushback is coming from is an interesting question – it’s hard to see how a small group of investors and hedge funds could influence or obstruct any kind of legislation.”