Of hamsters and vultures
Even entire countries can be sold off at rock-bottom prices
There is a status ranking for debt. Creditors normally rank above debtors in the moral hierarchy, but debtors also have their own pecking order: at the top are the first-class debtors, those who one can be certain will settle their debts. At the other end are the “junk bonds”. These bonds entail high risks for the purchaser because the issuers – the entities which create these securities – are either of low credit standing, or else the bonds themselves are issued in weak currencies. The risk to investors lies in the potential for defaults on the interest and capital repayments from the bonds. At the same time, these securities offer a chance to earn particularly high returns. Their junk status makes them attractive to risk-oriented investors. The tenuous relationship between treasure and junk is their unique selling point.
“Junk status” is, in the jargon of financial markets, the rating given to countries whose government bonds are assigned the lowest ranking by the rating agencies. In a system of ratings ranging from A to D, a triple-A rating tops the scale, while a D rating is reserved for defaults. Junk bonds typically have a rating of B or lower.
Strictly speaking, “junk” is not an accurate adjective for bonds that have lost value but could well regain it later. Junk lands on the tip, or at best in a one-euro store, but not in a speculator’s portfolio. In economic terms, junk would not be worth collecting. “Junk” bonds are therefore not genuine junk; they are financial products that have a low rating for the time being, but also the potential for their value to rise. These are bonds to which hardly anyone attaches any value for as long as their junk status applies, so they can be acquired cheaply and may well offer the opportunity to make a large profit.
The derogatory term “junk” offers a set of meanings that can range from plain insult to financial losses. But who in the financial markets decides whether something should be considered “junk”? It is first and foremost the rating agencies. Something only becomes “junk” when it is referred to as such. This is a performative act.
In theory, rating agencies play an important role because they provide information and so help to eliminate knowledge asymmetry. This should help financial markets perform more effectively. The rating agencies collect information, which they then analyse. They often have privileged access to private information. They get their knowledge from conversations with sources such as government representatives and bankers. But whether this gives the rating agencies an advantage in terms of information that would justify their leading function is doubtful. The significant economic and political parameters of countries – current account balance, level of debt, inflation and so on – are largely already available to the public, and projections of future development remain controversial, even among experts. In any case, rating agencies often only announce what is already public – although they do so in their assumed role of soothsayers, and attract a lot of attention.
The need for an ostensibly objective assessment with independent credit rating marks awarded by rating agencies stems from various segments of the financial market. Issuers want to see their bonds achieve a high rating, and investors want a realistic view of the situation. Analyses offered by the rating agencies influence the decisions made by investors and the actions of issuers. Therefore, rating agencies are often feared by private issuers and governments. They have the potential to stigmatize, something that already becomes apparent in the mere threat to lower a rating. It only takes the threat of a sell-off to prompt the requisite level of fear for governments to take action.
Countries that fear their bonds will suffer a downgrade must promise higher yields in order to attract investors, and this restricts their options when implementing economic policy. Less money is then available to fight poverty and support welfare policy. Sometimes a threat of junk status from the rating agencies may even be helpful. It permits governments to act in accordance with the market, and take measures they had already favoured, but present them as the outcome of circumstance. And what is more, they already have a scapegoat at hand: the financial markets.
But as regards the rating agencies, the financial market is almost the opposite of a perfect market, for the three largest agencies have carved it up between them. Moody’s and Standard & Poor’s control about eighty per cent of the market while Fitch controls fifteen per cent. It is an oligopolistic rather than a competitive market. In any case, the rating agencies do not occupy a democratically based position of power. And from the technocratic perspective too, the list of their misjudgements is long.
Argentina’s junk status
In the 1920s, Argentina was one of the richest countries in the world. Its natural resources promised a prosperous future. Yet things turned out differently. State bankruptcies have occurred frequently in Argentina’s history, causing the country much pain right up to today. The first occurred in 1827, followed by another in 1890. During the 1950s, Argentina went bankrupt twice, a performance that was repeated in the 1980s. Yet the most spectacular bankruptcy so far happened in 2001. It was preceded by a deep recession. Gross domestic product (GDP) fell more steeply than at any point since the Great Depression of the 1930s. It resulted in scarce foreign exchange and galloping inflation. The country slipped into political chaos. Over half the population lived in poverty at certain intervals, and the unemployment rate rose to over twenty per cent.
Argentinian debt securities were rescheduled in 2005 and 2010, with over 92 per cent of creditors accepting a considerable reduction in their claims. They received GDP-indexed bonds in exchange for the junk bonds; the higher the future economic growth, the higher the return on the former. This move paid off, as GDP rose significantly. The bonds linked the interests of national politics in favourable economic development with the interests of international investors in achieving the highest possible returns. Therefore, the Republic of Argentina was successful in reaching agreements with the vast majority of its creditors during the 2000s, in which the creditors accepted a reduction in their claims. However, seven per cent of creditors were not prepared to swallow any such agreement and held on to their bonds or tried to sell them to investors with an even higher tolerance of risk.
Despite Argentina’s long history of bankruptcies and debt relief, foreign investors unafraid of payment default have always been found to buy Argentinian government bonds. High-risk Argentinian junk bonds had a high yield. They were the subject of a classic process, where selling them at a loss was intended to keep less valuable securities in the economic cycle, instead of eliminating them.
One need not go to a bazaar in order to get rid of government bonds. A negative rating from the rating agencies will suffice to trigger their cut-price sale. The country’s economic policy must then prove itself in both political and economic terms, while financial markets “keep a close watch”, as the economic press are fond of saying. Then the markets demand a low level of new debt, a competitive exchange rate and lean state aid. The financial market is said to restore a failed economic policy to the path of virtue.
The return on the Argentinian bonds was so high because it included a risk premium to compensate for Argentina’s potential bankruptcy. Anyone buying such junk bonds either consciously accepts this risk or is unaware of it. But the high interest rates clearly indicate the probability of state bankruptcy. If a country pays a risk premium on its debt, this points to a potential for bankruptcy. The greater the risk, the higher the premium.
Scavengers are not collectors
In Adorno’s portrait of Walter Benjamin as a collector, we find the antithesis to the vulture: “At the same time he had something – again it is difficult to find the right word – something of an animal which stores supplies in its cheeks. The moment of the antiquarian and the collector, which plays such a prominent role in his thinking, has also marked his physiognomic appearance.” The hamster not only looks unlike a vulture, but its actions also differ entirely from those of the scavenger. It is loved by economists, because during the good times it saves for the bad times. In economic jargon, the hamster “smooths” consumption out, over its lifetime. Scavengers live differently and do not collect supplies in anticipation of the harsh winter season, but gulp down what others leave.
In the summer of 2014, on 30 July, Argentina’s creditors received no further payments on their bonds. Although Argentina had deposited 539 million US dollars at the Bank of New York Mellon, the bank was not allowed to transfer these funds to the creditors. What had happened? Argentina intended to fulfil its liabilities towards the creditors, yet US Federal Judge Thomas Griesa of New York did not allow the country to service its debt. Griesa’s decision ruled in favour of the claims of hedge funds that had brought an action in New York. They were memorably billed as the “vulture funds”. The vultures had bought Argentinian debt securities at a bargain price, a “knockdown” price. In other words, they paid a fraction of the nominal value printed on the bonds. They obtained the securities from investors resigned to receiving no further payments for their junk bonds. But the vultures bought where others lost their nerve. They were not part of a no risk no fun party, but had coolly calculated that under US law, they could sue for the full servicing of their bonds at nominal value, plus interest.
The junk dealer is the opposite of a collector: Walter Benjamin understood that “a collector’s attitude toward his possessions stems from an owner’s feeling of responsibility toward his property.”
Lioness versus vulture
Vultures are popular scapegoats. Their repulsive behaviour helps to hide political errors and obscure responsibilities. The crucial issue is actually the fact that politics has liberalized financial markets and so handed over economic policy to the market.
In recent years, the media have portrayed the Argentinian government as a poor country in the South which is ready to fulfil its obligations to the creditors, but which has been barred from doing so by a US-American judge. On the one hand there is Cristina Fernández de Kirchner, the president of Argentina, as the lioness fighting for her fatherland, and on the other there are the greedy vultures who are being put to flight by Kirchner (“patria o buitres“).
The Twitter hashtag #griesafault demonstrates the enormous international media attention given periodically to the dispute in Cono Sur, at the world’s end. Both sides used the media for their own interests, each staging a heart-rending moral campaign. Whilst the vultures in the United States castigated the transgressions of a stubborn Argentinian female president and portrayed a state bankruptcy with disastrous consequences for Argentina, the Argentinian government let off nationalistic fireworks and interpreted the loss-making sale of the Argentinian government bonds as an insult to the people. Yet the hedge funds were not interested in the living conditions in Buenos Aires after a fresh state bankruptcy, but in lucrative business concerns. And naturally, the Argentinian government did not really believe that the vultures intended to humiliate the proud nation of Argentina. Yet as a performance, the strategy worked: the appeal to national pride with demonstrations at historically significant sites in Buenos Aires did not go unnoticed, and helped substantially increase Kirchner’s popularity. Conversely, the hedge fund managers forecast doom and destruction in advance of the court ruling on 30 July 2014, pointing to the frightful consequences of a second bankruptcy within thirteen years for the people of Argentina. But local financial markets continued to function without complaint.
Soap opera of the elites
Hedge funds are the one group of bond creditors that acts more aggressively and more doggedly than other financiers. They are more powerful than small investors and some of them are specialists in junk bonds. Paul Singer is probably one of the best-known figures in the business. “The man who brings down countries”: thus the headline of an article in the German daily newspaper taz on Singer and Argentina. Paul Singer is a generous financier of the Republican Party in the United States, a man who does not seek the limelight. His firm NML Capital, a subsidiary of Elliot Management, invested 48 million US dollars in Argentinian government bonds. Singer is said to have bought the cheapest of these debt securities for fifteen cents on the US dollar: in other words, he paid less than one sixth of the bonds’ nominal value. According to Griesa’s ruling, he ought now to receive 832 million US dollars. This would amount to a return of over 1600 per cent.
As a result of Argentina’s state bankruptcy, Singer tried to seize Argentinian public assets wherever he was able to get hold of them. The seizure of an Argentinian naval vessel in Ghana was a sensational affair. A local court temporarily upheld Singer’s claim until the International Tribunal for the Law of the Sea decided otherwise. During the 1990s, Singer acquired Peruvian debt securities at a knockdown price and took legal proceedings in the United States and Europe. The seizure of Peruvian assets in the United States was upheld by the US courts. Exasperated, the Peruvian government ultimately paid up and entered into a settlement with Singer. He was also successful in his use of litigation against the Republic of Congo.
Hedge funds are almost unanimously considered to act “immorally”. But to speak of “morals” misses the point in the case of junk bonds, for at least two reasons. The term suggests that what happens in financial markets is basically fair, though there may be some unfortunate excesses (excessive bonuses, speculation, shadow banks). Yet vultures do not turn into eagles even if they aim to achieve only a 10 per cent return rather than one of 1600 per cent. Moreover, the simple dichotomy between “winners” and “losers” is too narrow, because it refers only to elites. People living in poverty obviously do not hold government bonds, whether junk or triple-A, and the state only helps them when not otherwise engaged in corrupt practices at the behest of its own clientele.
Argentina as a weak state in the South fighting evil speculators in the affluent North who reside in capitalism’s showcase country: this is an image that invites further misleading dichotomies. In fact, the Argentinian state intentionally issued its bonds under US law, because it expected to gain by doing so. The decision to issue the bonds in US dollars under US law was meant to compensate for the lack of confidence in Argentinian stocks. Only then would the bonds become attractive to rich American investors, and it is for this very reason that the Republic of Argentina now has to wrangle with hedge funds before US courts. For people living in poverty in Argentina, state corruption, high inflation and high unemployment are still the most pressing problems. The fact that behind the official imagery there are power shifts at a global level that perpetuate their lack of opportunity is obscured.
Kirchner, the Argentinian president, argued that there could be no talk of bankruptcy. Those who go bankrupt are not known to settle their debts, whilst Argentina had deposited funds with the Bank of New York. The fact that it was not possible to pay the creditors was purely a consequence of the ban that stemmed from the court’s ruling.
A lioness’ fight against vultures, an uncompromising US Judge Griesa or a pitiless speculator like Singer, who has already successfully sued a Latin American country: these are the ingredients for success in a Latin American soap opera. To be characterized as junk, without value, is insulting. In the case of government bonds this affront can be diverted along patriotic lines and construed as an injury to national pride. Yet the symbolic insult inflicted by selling at a loss, and associated references to moral categories, serve only to mask the real issue of where economic power actually lies.
Junk is business
The capitalist creed states that what insolvent debtors need is a new start. Debt remissions and rescheduling ensure that financial markets continue to work in times of crisis. Since the 1970s, private investors, hedge funds for example, have also been able to bring legal actions in the United States against defaulting countries. This indicates a drastic shift of power away from the state towards business.
The ruling by US Judge Griesa in the case of the hedge funds versus the Republic of Argentina, if looked at closely, equates to a ban on sovereign bankruptcy and therefore runs counter to the principles of capitalism. Failure is viewed as inherent to the capitalist system and is even welcomed if it gives rise to a new start. The cancellation of debt is supposed to have a cleansing effect and has occurred numerous times in the past. The players in financial markets therefore distinguish between a genuine payment default in which bonds actually become “junk”, and a “Griesa fault”. The interest rates on various types of Argentinian corporate loans did not change at all in response to the US ruling at first. You would have expected the rates to rise. Criticism of the Griesa decision was voiced not just in Argentina, but also from the centre of the financial world, by sources such as the major investor George Soros. But also the Nobel laureate, Robert Solow, warned in an open letter that sovereign governments might seek alternative countries in which to issue their securities, perhaps the United Kingdom. This would prompt fears that US business would suffer as a result.
As soon as Alexei, the protagonist in Dostoyevsky’s novel The Gambler, starts to win, he stakes yet more on the next round at the gaming table; he cannot control himself. But the actions of the vulture funds had nothing to do with playing roulette in a casino, because the vultures could keep control of themselves. In any event, they hedged their risk with credit default swaps (CDS), which afford insurance against the risk of bankruptcy. For a premium (the CDS spread), the CDS seller undertakes to make a compensating payment to the buyer in the event of default or a delay in payment. The level of the CDS spread depends in particular on the credit standing of the reference debtor, the definition of the credit event and the duration of the agreement. If bonds become worthless, the creditors are paid. Therefore vulture funds also acquired CDSs. With this financial instrument in their pockets, they had less incentive to reach an agreement with the debtors. Whatever happened, they would win.
The poor get nothing
The rating agencies’ assessments are based on changes seen over time rather than on a given result at a given time. It’s a matter of selling at a loss and upgrading. Anything can become junk, but much of it will also lose its junk status in time. The context of the market assessment is rigidly geared to the hegemonic ideology – financial market good, welfare state bad – but the loss-making sale itself can be prompted by many indicators: a weakening exchange rate, exploding sovereign debt or excessive inflation. The classification as junk should be followed by a change in economic policy, which should lead back to the path of market-led “virtue”. The word “junk” when referring to bonds and countries therefore merits assessment over time and by means of the comparison: junkier and less junky. Selling at a loss initiates a process intended to purify the debtor. The “Griesafault” was not a shock to the financial world. The Argentinian tragedy of 2001 did not recur as a screwball comedy. That said, it would be an exaggeration to launch into “Don’t cry for me, Argentina”, because repulsive stories about vultures do not even touch upon the situation of the poor or even of the middle classes. The majority of the population can only look on as the media portray disputes among government and financial elites as if they were a poker game; as with a football match, it may keep its fingers crossed for its own nation. Criticism of a policy that writes off society is then overlooked. The media’s depiction of poor and rich as North versus South, USA versus Argentina, downplays the issue of distribution within Argentina and concentrates in a moralizing manner on the topic of guilt. In Shakespeare’s Hamlet, Polonius advised his son Laertes: “Neither a borrower, nor a lender be; / For loan oft loses both itself and friend, / And borrowing dulls the edge of husbandry.” This Hamlet universe can get along fine without the large group of those poor in assets or totally devoid of assets, most of whom have nothing to hide; neither do they generally receive credit, since they have no collateral to offer in return. And should they obtain a loan on their property – which has become valuable for now, as a result of speculation – then consumption on credit goes awry, as the US crisis itself demonstrated.
Morals and shame have a role to play in the orchestration of the knockdown sale, but they remain superficial phenomena, a mere PR gag along the lines of “forgive us our trespasses, as we forgive them that trespass against us”. Yet debt is not a synonym for sin. In financial capitalism, the relationship between debtors and creditors is simply a social relationship in which the balance of power is always being renegotiated.