Jay Newman was a senior portfolio manager at Elliott Management and is the author of the finance thriller Undermoney. Benjamin Heller is a portfolio manager at HBK Capital Management, specializing in emerging markets.
The world of distressed sovereign debt seems to attract bad ideas like no other, mostly concocted by G-20 bureaucrats and the International Monetary Fund.
The most recent is the Common Framework for Debt Treatment, which is neither general nor a framework, but rather a reimagining of the ad hoc nature of the process for resolving sovereign defaults. Twenty years ago it was the sovereign debt restructuring mechanism, a Trojan horse to establish a unanimous bankruptcy court chaired by the IMF, itself a creditor and expert witness. And let’s not forget the Heavily Indebted Poor Countries Initiative, a program that relieves badly managed, corrupt countries of their obligations without generating growth, strong domestic institutions, or permanently clean balance sheets. is
We also have the IMF and the G-7 to thank for the loosening of collective action clauses, cleverly transforming them from a tool into a poison pill to facilitate systematic restructuring that operationally defaults on sovereign debt. does not make it applicable to
But the granddaddy of bad ideas is the so-called Brady Plan, a scheme that – if it hadn’t been designed and blessed by the US government – would have landed many people in prison for accounting fraud.
Simply put, the Brady Plan replaced the long-term zero-coupon U.S. Packaged defaulted and distressed junk sovereign debt with Treasury bonds. The express purpose—the only purpose—was to enable insolvent Western banks to avoid recognizing huge losses on their portfolios of developing-country debt. Brady bonds never made any economic sense. But those were the days: when bank regulators did their patriotic duty, turned a blind eye to the deep holes in bank balance sheets and did just that. . . nothing
Ironically, once the new bonds left bank balance sheets, bondholders and issuers spent the late 1990s and early 2000s unraveling the collateral Bradys—and from taking apart a structure. Sharing benefits not available to both parties was economically inefficient.
Now, two experts on complex financial and legal structures, Lee Bouchet and Adam Lerick, are proposing to recycle the Brady plan. The FT’s Martin Wolf wrote in January about how the plan offers a potential escape route for “low- and lower-middle-income countries” that have “taken on too much of the wrong kind of debt.”
That is a fair point. But whether, as he concludes, that “primarily reflects a lack of good alternatives” is open to debate.
There is plenty of room for skepticism about the mechanics of applying the template, as FT Alphaville has already pointed out. Not least that it proposes the creation of the kind of structural complexity that only a quantitatively minded hedge fund trader might like.
To wit: “This proposal would convert the entire debt stock . . . into 25-40 year debt,” which “should reduce the net present value of debt by more than 50 percent and put debt on a sustainable path.” must.” The reduction will be accomplished by offering bondholders a “cash downpayment” funded by new zero-coupon loans from the World Bank and IMF.
Of course, the World Bank can use “derivatives . . . in a standard zero-coupon . . . floating-rate liability.” Then there is a so-called support structure floor that enables the borrower to magically discharge those new loans at maturity. hmmm
The template may be impenetrable but at least (like the Brady plan) its heart is in the right place. Unfortunately, good intentions do not match clear purpose. As for the consequences, there will be a lot of new devices for well-paid hedge funders and bankers to slice and dice and a lot of new money flowing through the system. How the plan will address any real problems, however, remains a mystery.
Many of these “big” ideas are produced by or on the backs of international organizations. Essentially, they are solutions in search of problems to be solved directly. It is a sly bit of intellectual prestige to associate bankruptcy with a “debt problem”—as if the burden of debt had descended on the country unimpeded like an alien spacecraft.
Is the problem only debt? Or is it a complete failure to mobilize financial resources? Or poor management of those resources? Failing to create a fertile environment for growth? It is strange to think that – to take a random example of a country where there is talk of a possible debt restructuring – Nigeria needs to write off the debt, but nothing needs to be done about the fact that the country mobilizes 6 percent. GDP in Tax Revenue
Another current event is the case of Sri Lanka: the IMF, as always, intends to implement its opinion on debt sustainability. It is long past time for borrowers to come up with their own criteria for sustainability, as bank advisory committees did in the 1980s. Unlike the IMF, private lenders will propose realistic parameters for fiscal efforts and reject a sandbagged growth trajectory based on the soft orthodoxy of low expectations.
What never comes up in the countless conferences on sovereign debt, or official sector-led research and discussions, are the root causes of sovereign debt defaults: corruption, weak governance and domestic institutions, refusal to borrow in foreign currencies. to do, and failure to arrest the decline, much less to recover ill-gotten gains.
At some level, Buchite and Larrick understand that serial defaulters have problems that go beyond the existence of debt. A sensible part of their proposal calls for structural restraints on borrowers’ ability to re-leverage themselves with new lending after going through their neo-Brady Rube Goldberg machine. They know better than to put a non-recovering alcoholic next to an unlocked liquor cabinet.
Yet, for the official sector, lackluster financial performance, political mismanagement, and co-occurring debt problems are more of an opportunity than a problem. The problems, after all, are theirs raison d’être.
Countries are often poor because they are badly governed by a political class intent on collecting rents, not providing honest services. Fancy templates, frameworks, initiatives, and plans ignore the root causes of human suffering resulting from this abuse. They are misdirected, solve nothing, obscure fundamental problems, and absorb attention that could be productively directed toward solving them.
