Exploitation Investment Funds
Michel Morkos Al Hayat - 12/05/08//
As time passes by following the US subprime mortgage crisis, the direct and indirect losses incurred by the financial institutions and the banking sector are mounting, while the announced data unveil hidden financial disasters. Though some countries did cast a doubt over the IMF's estimates setting the incurred losses at around $1 trillion, the real losses may actually exceed the estimated figure. However, parallel to these losses, the distressed institutions are now in need of partners to bail them off, in particular high net worth individuals or public sovereign funds. Nevertheless, when they acquired assets in US or EU entities, the sovereign funds were met with severe criticism from politicians and economic observers who feared that these funds would jeopardize the country's national security or the production identity of the institutions, object of ownership or partnership.
The institutions in distress are highly attractive to international investors, whether sovereign, investment or hedge funds. They shed the value of their stocks put up to sale, often to very cheap levels incomparable to the real or healthy market values. By devaluing its shares, the company in question generally seeks to attain two goals: either entice investors to pursue their investment despite the heavy losses incurred or lure new investors in order to raise its capital. In both cases, non-sovereign investors keep their eye on the weak company stocks.
Twenty years ago, another kind of investment funds appeared. Known as the "vulture funds," they can be also called "exploitation funds" due to their nature. These are financial institutions that primarily buy bonds, whether corporate or industry shares, doubtful loans, rights or dividends. They started first by buying up the doubtful loans then pounce to buy the prey cheaply, hence their name, vulture.
Set up in the US, these funds flourished in the aftermath of the bankruptcy of energy broker Enron in 2001 and the communication operator WorldCom in 2002. After the two crises, as the banks wanted to get rid of the riskiest loans, they allowed these funds to grow. Francois Four, then manager of US bank Houlihan Lokey Howard and Zokin, said: "Instead of supplying their accounts with risky corporate loans, banks sold them in banking debt markets by organizing public auctions to this end." At the beginning of the third millennium, similar funds started functioning in France, taking advantage of the successive recreation and excessive restructuring of the accumulating outstanding corporate debts at the end of the last decade.
These exploitation funds feed on the miseries of others and grow richer thanks to institutions on the brink of bankruptcy. These funds are financial institutions that buy doubtful debts cheap and sell them high. However, they turned toward the debts of the poor countries in the third world. When these indebted countries default, the exploitation funds sue them in courts for full repayment of the loan along with the interest and delay fines. In the same vein, the US fund, Donegal, bought in 1999 debts that Romania had lent to Zambia. They were worth $3 million, but their true value stood at $15 million. Donegal sued Zambia in British courts asking for $55 million plus arrears. Donegal partially won the claim and the court forced Zambia to pay $17 million, at an additional value exceeding by 500% the initial debt paid at the expense of the poorest country in the world. Congo-Brazzaville faced a similar case with Kensington Fund, as well as Argentina.
According to the IMF, 46 similar-type lawsuits, worth $2 billion, are handled by courts. Even though they might look marginal when compared to Countries of the South's overall external debts ($1600 billion), they can represent a lot to poor countries. In Nicaragua, a similar fund recovered $276 million, an amount that exceeds the country's annual health budget.
In spite of being a type of hedge funds, managing only 5 percent of the overall 2-billion-dollar value of bonds managed by hedge funds, they threaten the development targets of the loans given to poor countries. Hence, the donor countries and the Paris Club are now intent on stopping these funds that hamper social goals, as they resort to courts. In this respect, Belgium adopted a more stringent approach to these funds. For instance, it endorsed in December 31 a law that prohibits such financial institutions from taking over Belgian aids reserved for development in indebted countries.
These funds force donor countries to strengthen the social spending critical for debt-distressed countries. Therefore, a general principle must be laid down and applied to both private and public creditors. An international debt law must be enacted in such a way that limits the rights of creditors and protects debtors. The subject is more plausible today, due to the balance of powers. Rich countries fear the competition posed by emerging countries, especially China, so they lend poor countries without reserve, recreating the saturated debts cycle.
The G8 countries and the Paris Club want to stop the mechanisms that make funds richer as they benefit from the loans of rich countries. Therefore, they put forth the "Responsible Lending Charter" at the 2007 G8 Summit. However, this move will not be cemented unless the countries themselves assume their responsibilities towards the Countries of the South.
These funds are apparently more fearful than sovereign funds, especially that the currently bankrupt financial institutions constitute an easy prey for them!
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