'Vulture fund' investors make millions out of third world debt crisis

The practices of 'vulture funds' which buy up cheap soveriegn debt on the secondary markets, and then sue for full-repayment plus interest, came to international attention this week. The spotlight is on a New York based hedge fund called Elliott Associates L.P. who sued the Peruvian government to make a $47 million profit on debt bought for just $11 million. In the process, the hedge fund nearly caused the Peruvian government to default on their Brady bond payments. Jubilee 2000, who are campaigning for a fair and transparent process of debt cancellation so that debtors and creditors get equal treatment, said that the recent developments in Peru were clear evidence that new controls are needed.

Last week, the Financial Times reported that Peru had made a one off payment to Elliott Associates L.P. of $58 million. The payment followed a legal battle between the Peruvian government and the hedge fund which sued Peru for full-cost payment of cheap debt bought on the secondary markets. In 1996, Elliot Associates paid only $11 million to buy up $20 million worth some of Peru's debt. Paul Singer, a general partner at Elliott Associates said "Peru would either... pay us in full or be sued." Singer's firm succeeded, successfully suing the Peruvian government for full payment of the debt plus capitalised interest, receiving a payment of $58 million on Oct 7.

The actions of Elliott Associates L.P. nearly caused Peru to default on their Brady bond deal, which would have thrown the country further into economic chaos. The hedge fund was the only of Peru's creditors to operate outside a package designed to help Peru manage it's $3.7 billion Brady bond debt.

Initially, a New York trial court found in favour of the Peruvian government, ruling against Elliott Associates L.P's case to reclaim the full value of the debt on the grounds that it was illegal to buy debt with the sole intention of suing the debtor for repayment. However, this decision was overturned by the Federal Court of Appeal, following the hedge fund's successful attempt to change the law.

The individuals involved in the Peru case, Paul Singer, adviser Jay Newman and attorney Michael Straus, have amongst them carried out similar practices concerning debt owed by Panama, Ecuador, Poland, Côte d'Ivoire, Turkmenistan and the Democratic Republic of Congo. The Group of Seven (G7) leaders promised regulation of hedge funds following the Asian and Russian crises in 1997/8 and the destabilising role played by the collapse of hedge fund Long Term Capital Management (LTCM). No action has yet been taken.

Liana Cisneros, Head of Jubilee 2000's Latin American Campaign: "These people are trading in human misery. Elliott Associates L.P. are picking over the bones of the Peruvian economy like a pack of vultures. It may be just business to them, but to the Peruvians it represents schoolbooks, medicine and clean water.

"The US Treasury must investigate this case as a matter of urgency and take immediate steps to stop these scandalous practices."

When a country is facing economic difficulties and falls into arrears on sovereign debt, creditors can trade this debt on the secondary markets. Investors can pick up debt at bargain rates, and will usually still make a profit on it because of debt restructuring, which means countries are forced to reschedule payments at an "affordable" level. Despite inability to repay in full, reduced payments will continue.

In the case of the vulture fund practices which have come to light, even more money is extracted from the debtor government through clever use of law - repayments from the government are frozen until a "preferred" creditor (in this case Elliott Associates L.P.) is paid who refuses to participate in joint-creditor negotiations. Debtor governments who cannot afford to default on loans for reasons of market confidence, have no choice but to pay off the vultures so that agreed scheduled payments to other creditors can go ahead.

In the case of Peru, Elliott Associates L.P. took out legal injunctions in six countries Canada, Belgium, Luxembourg, Holland, Germany and the UK to prevent the government from repaying other creditors until the hedge fund had received payment in full. This almost resulted in a Brady-bond default which would have plunged the country further into economic chaos.

Other Brady bond holders have scheduled payments of around $80 million twice a year from Peru, the most recent due on October 7, 2000. In order to avoid defaulting on this payment which had been frozen by Elliott Associates, the government chose to make the payment that Elliott Associates L.P. had asked for. Had the New York hedge fund opted to participate with all the other Brady bond holders, it still would have made a hefty profit, realising about $10 million.

Jubilee 2000 condemns these practices and is calling for tough controls to ensure that when a country faces economic bankruptcy private investors cannot see their own payments met at the expense of other creditors or of the government itself.

• Open letter from Jubilee 2000 Coalition: Vultures of the poor of Peru