A new term has emerged in recent months for those struggling to understand the arcane arrangements made to reduce national debts. “Vulture funds” are a new by-product of cutthroat capitalism: speculators who buy up the national debts of poor countries with the intention of bypassing customary, but not legally binding, financial practices in order to make huge profits at the expense of some of the most impoverished people in the world.

Vulture funds make their profit by exploiting the important distinction between “face value” and “market value” of national debts. While the IMF, World Bank, and other multilateral institutions (e.g. the Inter-American Development Bank) have long insisted on full repayment of all debts owed them, most bilateral (i.e., governmental) and private creditors have often been willing to accept less than the formal principal (face value) of the original loan. The “Paris Club” of creditor governments exists precisely to coordinate the percentage of debts that bilateral creditors will accept. The lesser-known “London Club” coordinates the same calculation for banks and other private-sector creditors.

There is a “secondary market” for trading debt contracts. Through it, one can buy debts owed by a national government, say Uganda. The trading price of the debts of the most impoverished countries (such as Uganda) is generally about 10% of the face value. What the buyer purchases is the right to collect the face value, but it is only very recently that some speculators have begun to apply that right literally by rejecting international debt reduction agreements and instead demanding, through lawsuits against the debtor governments, 100% repayment.

Debt “relief” programs like the joint IMF/World Bank Heavily Indebted Poor Countries (HIPC) Initiative are already insufficient, more focused on forcing countries to accept new structural adjustment programs than on reducing poverty or creating sustainable growth. The emergence of vulture funds highlights another critical weakness of these programs: they are only ‘gentlemen’s agreements’ with no legal enforcement mechanisms.

The case which brought vulture funds to international attention involves Peru. A U.S.-based hedge fund, Elliott Associates L.P., paid $11 million in 1996 on the secondary debt market to buy $20 million (face value) of Peru’s sovereign debt and then sued for full repayment plus capitalized interest. A Federal Court of Appeals, overturning a state court, ruled in the firm’s favor.

Elliott Associates then took legal action in Canada, Belgium, Luxembourg, the Netherlands, Germany and the U.K., serving restraining orders on any payment on Peru’s “Brady bonds” — devices issued as part of a debt reduction initiative in the late 1980s. Because of the legal decision in New York, they were able to argue that they had preferred creditor status, and that no payment should be made on any Brady bond until Elliott Associates had been fully repaid. Peru makes two payments each year of about $80 million to its Brady bond holders, but the freeze on payments meant that Peru faced defaulting on its Brady bonds.

Default on Brady bonds — which had been unprecedented until Ecuador, with the blessing of the IMF, suspended payments in 2000 — would have likely caused private investors to avoid Peru. The Peruvian government was thus forced to pay Elliott Associates $58 million in October 2001, providing the firm with a $47 million profit on its original $11 million investment. That $47 million, of course, now goes to wealthy and clever U.S. businesspeople instead of to support programs for the impoverished people of Peru.

Other countries that Elliott Associates appears to be considering attacking include Panama, Ecuador, Poland, Côte d’Ivoire, Turkmenistan and the Democratic Republic of the Congo. Other firms appear to be targeting Yemen and Cameroon.

In another case, Nicaragua confronts the possibility of suffering Peru’s fate. When the World Bank administered a commercial debt “buyback” in 1995, several commercial creditors declined to accept the offer price of roughly 8 cents for each dollar in face value. The Leucadia holding company was one of these creditors, having purchased Nicaraguan debt in the secondary market. It began legal proceedings to force repayment in 1996. In April 1999, the U.S. Federal District Court for the Southern District of New York entered a summary judgment against the government of Nicaragua for $87 million (including both the principal and interest accrued). This amount represents more than three times the face value of the original principal of $26 million which Leucadia bought for $1.14 million. Leucadia has since tried unsuccessfully to collect on the ruling by “attaching” (requesting that a court order funds diverted to it) Nicaraguan assets in the United States — specifically, the Nicaraguan government’s portion of revenues from airline tickets to and from Nicaragua sold by American and Continental Airlines). In September 2000, Leucadia initiated court action in the U.K. seeking enforcement of the 1999 U.S. ruling. The U.K. court ruled in favor of Leucadia in February 2001, with no defense offered by the Nicaraguan government.

The World Bank has indicated its awareness of and concern about vulture funds recently. Commercial creditors are expected to participate in the HIPC process, so the vultures’ maneuvers could seriously undermine what relief is on offer from HIPC. In an effort to preserve HIPC’s claim to provide meaningful debt relief, the Bank may well have to bolster the funding it provides on a grant basis to HIPC countries for commercial debt buy-backs. With 23 countries pursuing HIPC relief, and the vulture funds’ tactics only recently coming to light, we may just be at the beginning of a serious new complication for efforts to eliminate the burden of external debt.