John McKenzie

Argentina has been struggling with its external debt for over 14 years, during which it has attracted financial predators of the nastiest kind.  Technically called ‘distressed security funds’ in the finance world but more popularly known as ‘vulture funds’, these large hedge funds pursue a profit strategy of buying securities such as sovereign bonds in distressed investments in or near default. As their nickname suggests, vulture funds set flight in search of waste no longer wanted by others. In financial markets, they scavenge for what the average investor would consider an unrecoverable investment.

While the high-risk security changes hands, the financial obligation for the bond issuer remains unchanged. Why does a vulture fund buy debt from anxious investors when the probability of realising the purchased assets is low?  Once they buy the waste, vulture funds want to recover at least what they paid for it plus interest. So, how do vulture funds profit from buying unwanted securities? The answer to this question lies in the clever strategy of these funds. Vulture funds are market makers in that they offer a way out to average investors, who realise that their investment, say in the form of bonds issued by the Argentinian government, is unlikely to be paid back in full. This was the case for most foreign debt creditors when Argentina first defaulted in 2001. Faced with the possibility of losing all their invested money, most creditors turned to the rather less painful alternative of selling their securities to vulture funds at prices often ranging between 10% and 30% of their original issue value. When a firm or a country defaults on its debt or is close to bankruptcy, it often resorts to some arrangement of debt restructuring. Argentina was allowed to do so after its first default in 2001, but its restructuring plans did not embrace vulture fund creditors, as they would not agree to any debt relief verdict.

Unlike the average investor, vulture funds rely on their massive litigation power to twist the debtor´s arm and obtain a debt settlement of the securities at stake with little or no tolerance to adhere to any sort of debt restructuring. In the case of Argentina, whereas 92% of Argentina’s creditors eventually agreed to the government’s restructuring proposals, the remaining 8% (with the largest being Elliot Management Corporation), were holdouts. Elliot’s rigid holdout strategy has meant many problems for Argentina, and eventually led to a second default in July 2014.

Elliot Management has spent a good part of the last decade suing Argentina to force repayment of its debt. Elliot Management’s tactics have been even more aggressive when suits failed. In 2012, Elliot Management convinced Ghanaian port officials to seize an Argentinian naval vessel valued at about $15 million in an attempt to collect the money owed by the country. An agreement could not be met and the vessel was released in the end. However, this incident triggered much tension between Argentina and Elliot Management. The two parties have each now adopted very aggressive positions, mostly due to intransigency.

More recently, Elliot Management took additional legal action and succeeded in getting New York judge Thomas Griesa to rule that holdouts would be paid on an equal basis as the regular debt creditors who had agreed to Argentina´s debt-restructuring plans. Although Argentina had the money to pay its regular debt creditors, Argentina chose to default for a second time in July 2014 rather than pay billions to Elliot Management as well.

Though the New York judge’s decision left bondholders disappointed, Argentina is not very satisfied either, since it was forced to default. This is clearly a situation that could be well modelled in game theory, with both parties not willing to yield to the other, and both arriving at the worst outcome when nobody cooperates. That is a prisoner´s dilemma, or an all-lose game.

Or is it? The problem is actually not that complicated. Argentina will have to pay the debt sooner or later plus 8% interest on the missed payment, but in the meantime it might as well keep on defaulting, or at least for a couple more times. The intriguing question is what Elliot Management will plan to do now. So far, it has proven to be insatiable and ready to battle the fight irrespective of any and all costs. Standard game theory models would predict similar moves in terms of aggressiveness for each party. Argentina will probably want to take some legal action so as to rule out that holdouts are to be treated differently from the rest of its debt. Hence this would allow the country to pay the rather bigger fraction of investors who form part of the restructuring independently of the holdouts. On the other hand, if the legal course were to fail, Elliot would probably come out with even more ruthless strategies to force the payment. Maybe freeze more Argentinian assets in foreign soil? Try to claim other vessels? We can leave that to your imagination.

In fact, Argentina has already replied to Elliot´s action. In September 2014, the Argentinian government passed a new law in an effort to circumvent Judge Griesa’s ruling. Argentina’s new law will allow the country to pay its debt under foreign law in Buenos Aires or cities that are out of reach of US law. Unsurprisingly, Judge Griesa has not ratified such law and, thus has created even more uncertainty amongst the creditors. How will the current standoff between Argentina and Elliot Management end? No one knows, but it is a certainty that other nations, foreign-debt creditors, vulture funds – and even avid game theorists – are all watching the precedents being set with great interest.