Why Ignoring the Marine Insurance Act of 1746 is a Bad Idea, Part MCMXXVII

For those who don't remember, the Marine Insurance Act of 1746 required, "Anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property." (Link)

Basically, it means that you cannot purchase insurance on your neighbors home, and collect when you burn it down.

The act was passed because around that time, there was a war between Britain and France, and some people were purchasing insurance on ships, and then send the itinerary and manifest to accomplices in France, who would relay this information to the French navy, who would seize the ship, and the insurance fraudster and his accomplish would divide the spoils.

In 1999, it was decided that the form of insurance known as a Credit Default Swap wasn't insurance, because, well ……… because.

As a result, we have seen an explosion in speculators who insure things, and then blow them up.

Well it now appears that the Vulture funds who pushed Argentina into default may have engaged in this strategy:

So for Elliott an unseemly legal victory may not mean cold cash. Fear of default and/or eagerness to please Argentina may prompt some in the financial community to buy them out at a good price, but a sure thing that is not. Whatever American courts say, for all the reasons above, Argentina will probably not settle. Those bonds bought cheap (according to sources, Elliott spent close to $50 million purchasing about $220 million of old Argentinian bonds in 2008) may have looked to an informed observer beforehand quite unlikely to produce a decent return.

So why bother with an exorbitant legal fight? Well, the CDS route would be one reason. The likelihood of CDS triggering (failure to pay on foreign exchange bonds) would have appeared as very high precisely for all the reasons that make the likelihood of a settlement so low.

This scenario may have seemed plausible, at least more so than expecting Argentina to pay holdouts in full or something close to it. Elliott may have known payment is a long shot, but being a bondholder at least lets it try for a legal solution that could lead to default. That pari passu had been breached would have been a no brainer, for “all” you needed was to show that the country had legally subordinated you versus other creditors, and Argentina did that in 2005 by passing the so-called Lock Law prohibiting itself from making good on the holdouts (this was a key argument to have the courts declare a breach of pari passu; apparently, this kind of explicit de jure discrimination-subordination of creditors is very unusual).

Obtaining ratable payment as a remedy is unusual, though not unprecedented, but may have seemed like good odds in this case given the specific wording of the pari passu clause in question (which seemed to call for equal payments and not just equal rank) and the uniquely uncooperative character of the debtor; from reading the courts´ statements, one can sense that discomfort with the country´s attitude forced the judges´ hands towards a solution that in any other case may have seemed too harsh. Argentina´s behavior presented a unique opportunity to persuade a court to impose ratable payments; discipline for an unruly country.

With hindsight, Argentina was the perfect collaborator to have the CDS trigger: the Lock Law, tirades against holdouts, and contempt for court rulings on the way to its final refusal to settle guarantee that a failure to pay event materialised. For all the Kirchner government rage against speculators, in what would be a delicious paradox, it may have made the vultures rich by triggering the CDS.

This is actually a higher percentage strategy than getting 100¢ on the dollar from Argentina.

They make money, and in the process, they inflict enormous pain on the people of Argentina, and does damage to the US as a venue for sovereign debt.

I'm with Paul Volker when he said only the worthwhile innovation of this generation was the ATM.