Hello everybody, hope all is good. Quick update: I’m not releasing an interview this Friday due to scheduling issues. So you’ll get another deal instead. Sue me.
In other news, we’ve had an explosion of subscribers in the US. If anyone can tell me why, I'd love to know. My current theory is one of you OG subscribers sent my newsletter around to all your friends - if that was you, please reach out, I would love to thank you personally!
With that being said, let’s dive in!
Outline
When Lehman or Caesars can’t pay their creditors, what happens? They restructure debts, go into bankruptcy sometimes, and maybe even have to liquidate assets to pay debts.
When a country can’t pay their creditors, excrement hits the proverbial fan. It’s pretty hard to liquidate a country’s assets.
So today, I bring you one of the most famous sovereign debt lawsuits of recent times.
The stars of today’s show are:
a particularly ferocious hedge fund, Elliott Management, run by this guy:
a country unable to pay its debts, known for, amongst other things, this:
In case that wasn’t obvious, it’s Argentina.
I will show you how hedge funds use the law to bend entire countries to their will, earning sizeable returns in the process.
Timeline
1990s - 2002: Argentina, plagued by financial woes, begins defaulting on all external debt. Elliott begin buying Argentinian bonds at a discount - but these bonds have a very weird structure. These floating-rate accrual notes (FRANs) adjust according to Argentina’s creditworthiness, meaning the worse the Argentinian economy gets, the higher the interest payment. Elliott are buying bonds at a heavily discounted rate in the hopes they can enforce a full payment (plus interest) through negotiation and litigation.
2005 - 2010: Argentina attempt to restructure the debt, and 93% of creditors accept 30 cents on the dollar. However, this would be a boring newsletter if nothing crazy happened. Elliott and the remaining 7% refuse the deal. Why? They think Argentina can pay more. According to Moody’s:
‘The case of Argentina was and remains unique in its unilateral and coercive approach to the debt restructuring’
2012: A US court states Argentina must pay the hedge fund holdouts before the other creditors. Argentina doesn’t. Elliott seizes an Argentinian navy ship in Ghana, in an attempt to recover part of the debt. Chaos ensues.
2001 - 2014: Up to this point, Argentina has been in a protracted recession. Successive socialist governments refuse to negotiate with Elliott , criticising the fund and other holdouts as ‘vultures’ (the Kirchner family that produced two Presidents during this time period were later indicted on corruption charges… Lol).
2015: The socialist government is replaced by capitalist Mauricio Macri. Importantly, this guy is willing to negotiate with Elliott. At the same time, US courts state that Elliott has to be paid in full before any bondholders can be paid back. This essentially puts Argentina in a position where they can’t engage with capital markets until they pay Elliott.
2016: Argentina finally agrees to pay out, delivering a 1300% ROI.
Analysis
Why does Argentina keep defaulting?
When a company needs money, they can raise it through three main avenue: selling assets, issuing bonds, or issuing equity. Basically, Apple can sell a few factories (selling assets), receive some money from creditors now and pay it back later with interest payments along the way (issuing bonds), or sell 10% of themselves (issuing equity).
Countries can’t sell equity, and there’s only so many assets a nation can sell. So, countries in distress tend to issue bonds, even in the face of likely default. In Argentina’s case, this has led to nine defaults in the past 200 years, costing creditors tens of billions. The question, therefore, is why is Argentina so prone to defaulting?
Benjamin Gedan, head of the Argentinian Project at the Wilson Center, states:
‘They want to import products that requires dollars, they overspend and borrow in dollars, and they don’t generate dollars because they have a closed economy… That’s the story every time.’
Why do people keep lending these guys money?
Have a look at the table below, taken from a UN report. It shows the outcomes of lawsuits between hedge funds and defaulting nations:
Two things are of note. Firstly, look at the awards relative to the debt owed. These funds always win, and win big. Secondly, notice how five of these outcomes involved Elliott (Argentina is labelled as NML Capital - this is a subsidiary of Elliott). This is not a widespread thing, and sovereign debt is only really litigated by a few big players.
In essence, these funds keep buying debt that is likely to fail because they know they can collect. The Center for Popular Democracy sums the process up well (albeit with heavy bias):
Also, most sovereign debt lawsuits are litigated in New York, which has super hedge-fund-friendly laws. Namely, they don’t care about champerty, a doctrine that prevents purchasing or lending to people you know will default just so you can take them to court.
Key takeaway: A few funds have figured out a way to hold developing countries’ economies hostage, by dragging them through court and holding out during bond restructuring. Does it work? Nearly always. Should it? That’s more debatable, but this isn’t a philosophy newsletter.
Thank you for reading!
In week 1, we had mainly UK law students subscribing (my friends from law school and their immediate circle). In week 2, we started getting a lot more aspiring financiers from across the world. Now, halfway through week three, we have private equity investors, investment bankers, and lawyers making up significant numbers of our readership.
Ultimately, I want my content to be so digestible any student can understand it, and so valuable anyone involved in M&A, restructuring or the corporate world would benefit from it.
Probably won’t happen, but might as well have a crack.
Love from your neighbourhood nerd,
Alex
Further readings
Bloomberg, ‘One Country, Nine Defaults: Argentina Is Caught in a Vicious Cycle’
Forbes, ‘Argentina Vs. Billionaire Paul Singer’s Elliott Management: Who has the Upper Hand?’
Institutional Investor, ‘When Hedge Funds Hide’
The Center for Popular Democracy, ‘Pain and Profit in Sovereign Debt’
The New Yorker, ‘Paul Singer, Doomsday Investor’ (great title, amazing article)
The Washington Post, ‘How one hedge fund made $2 billion from Argentina’s economic collapse’ (rubbish title)
UN, ‘Dealing with uncooperative creditors in sovereign debt workouts’