In defense of vulture funds?

Whom does one root for when oil companies and vulture funds start going for each other's throats?

This is the question How the World Works is asking after following a path trail-blazed by financial journalist and prolific econoblogger Felix Salmon. On Monday, Salmon posted a very long and provocative analysis of the showdown between Zambia and the "vulture fund" Donegal International. In that case, the choice of rooting interest seems easy -- destitute African nation vs. greedy Western fund. But Salmon doesn't see it quite that simply. Drawing primarily on information gleaned from the 134-page U.K. High Court ruling in the case Salmon comes to the conclusion that vulture funds provide a necessary service for the global economy. They represent, in a torturous, bottom-feeding, carrion-nibbling kind of way, ultimate accountability. If it were easy for sovereign nations to default on their debts, argues Salmon, private sector lenders would be unwilling to advance them any further loans, which would end up further entrenching poor developing nations in their dire straits. He finishes his post with a contrarian flourish that is sure to send the blood boiling at the Oxfams of the world.

The fact is that private-sector capital flows to emerging markets are vastly larger and more important for development than public-sector flows from the likes of the World Bank. All of those private-sector capital flows are predicated, ultimately, on contract law. When trillions of dollars in flows are based on contract law, eventually some contracts are going to end up in court. And when a country gets taken to court, sometimes it will lose.

But if you add up all of the judgments awarded against all of the emerging-market countries which have ever been sued in the history of the international capital markets, the final number would be so minuscule in comparison with the magnitude of international capital flows to emerging-market sovereigns that it would barely constitute a rounding error. And yet the tiny outside chance that a country might one day be taken to court is absolutely crucial if that capital is to continue to flow. Big institutional investors don't like doing the work of suing sovereigns, so they essentially outsource that work by selling their defaulted debt to vulture funds. People might not like what the vulture funds do, but what they do is utterly necessary for everything else to function smoothly.

Oxfam has launched a campaign against Donegal entitled "Don't let the debt vultures make a killing". They should remember that vultures don't kill anything. There are lots of reasons why Zambians are living in abject poverty today, and Donegal's lawsuit is not one of them. Vulture funds create the conditions under which countries like Zambia can raise money for investments in health, education, and infrastructure. Maybe Oxfam should consider sending them a thank-you letter instead.

In his econoblogging, which I've been following for a year, Salmon has a tendency to put more faith in modern financial structures and the wisdom of capital than I do. But Salmon comes honestly by his expertise on vulture funds, or, as he prefers to call them, "distressed debt" funds, through his reporting for Euromoney magazine on a remarkable story involving the French bank BNP Paribas, a hedge fund called Kensington International, and the Republic of Congo.

That story is behind a pay wall, and the details of it are too fiendishly complex to summarize easily here, but the key thing I learned from it was that vulture funds aren't just suing sovereign nations in an attempt to get payment for the debt that they have purchased; they are also, increasingly, suing other companies that do business with those sovereign nations. Indeed, in the Congo, a pack of vulture funds have been suing Western oil companies in U.S. courts, arguing that payments those companies are making to the Congo government for current oil concessions should by rights go to the owners of the debt the Congo defaulted on years ago.

One U.S. company, CMS Nomeco, which is now a subsidiary of a European holding company, became so alarmed by the efforts of a vulture fund named AF-Cap Inc. to extract its pound of flesh, reports Salmon, that it took the ultimate step of setting up a Web site with the chill-inducing title of ThreatToOil.com.

AF-Cap believes it is entitled to "garnish" CMS Nomeco's royalties in payment for the debt it holds and has been suing for that payment in Texas District Court. It has similarly been pursuing Chevron in California courts. Its legal reasoning is convoluted: If you want the full rundown you can try this appellate court's decision from August in New Orleans or this one from California's 9th Circuit in January. In both cases, AF-Cap's efforts, although meeting with some early success in Texas, have been slapped down.

But it's not hard to understand why the oil companies are freaking out. There is no shortage of poor, developing nations in the world who have defaulted on debts to foreign lenders in the past few decades. If companies that currently do business with the governments of those nations can be held liable for previous debts to entirely separate parties, there's the potential for a lot of chaos.

It takes a lot of work to put an oil company in the position of aggrieved victim of rapacious greedy capitalists. It takes even more work, for me at least, to see the legal actions of funds like AF-Cap as part of a healthily working financial ecosystem that will ultimately help countries like the Republic of Congo find a more firm financial position. Neither the oil companies nor the vulture funds have the Congo's best interests at heart -- they're out to get what they can while they can, and if that means falling upon each other like crazed wolverines, well so be it. I would love to believe that through this struggle, red in tooth and claw, humanity will somehow benefit, but so far, it sure seems like sub-Saharan Africa is exhibit A of how it doesn't.