Felix Salmon

Could Cyprus go the way of Ecuador?

Felix Salmon
Mar 29, 2013 19:18 UTC

A small country which has adopted a major global currency finds itself with massive debts and insolvent banks. Its only real hope is that it controls areas rich in hydrocarbons; the problem is that it has neither the wealth nor the expertise to exploit those hydrocarbons on its own. The result: it ends up essentially selling itself to an omnivorous global superpower which is interested only in access to resources rather than in domestic economic growth and prosperity.

This is the narrative which might well end up playing out in Cyprus. The local population is so unhappy with the euro that they’re seriously looking to bitcoins as an alternative, despite the fact that there is no real bitcoin economy, and insofar as there is one, it’s inherently deflationary. Much of the country’s political, economic, and religious elite is seriously talking about leaving the euro. If they decided to do that, Cyprus would probably become even more controlled by Russia than it is already — especially given that Gazprom is by far the most obvious candidate when it comes to finding a partner which can exploit Cyprus’s natural gas reserves.

If you want to see an example of what this story looks like in practice, just take a look at Ecuador, which adopted the dollar as its national currency back in 2000. Since then, it has had a brutal debt restructuring, causing most foreigners to give up on putting their money into the country. Predictably, China stepped into the vacuum, and is now by far Ecuador’s largest source of funds.

The latest development is that Ecuador is probably going to sell about three million hectares of pristine Amazonian rainforest — that’s about 12% of the total area of Ecuador — to Chinese oil companies. Ecuador might not be drilling in Yasuni — yet — but this new parcel is right next door, and if the Chinese come in to drill for oil there, the effects on Yasuni can’t possibly be positive.

Ecuador’s indigenous population is up in arms, but is effectively powerless in the face of China’s tsunami of cash. For its part, China has no real interest in Ecuadorean economic growth or the wellbeing of its people; it just wants to control Ecuador’s natural resources, and is willing to pay many billions of dollars to do so.

If Cyprus once again restructures its debt and/or leaves the euro, could we end up in a world where Russia controls Cyprus to anywhere near the degree that China controls Ecuador? The answer to that has to be yes, given Russia’s imperial ambitions and the degree to which Russia’s wealth dwarfs anything in Cyprus right now. Cyprus has already announced that its harsh capital controls are going to be in place for at least a month; realistically, they’re likely to stay much longer than that. So long as they remain in place as the Cypriot economy suffers the deepest recession in the history of the eurozone, it’s going to be very difficult to persuade Cypriot voters to accept the status quo.

The EU, then, should be thinking very hard about how it can bring Cyprus back into the European fold. There are as many differences between Cyprus and Ecuador as there are similarities — but still, Ecuador is a sobering reminder that rich, resource-hungry powers really can end up essentially taking over a nominally sovereign democratic nation. For many years, the EU looked down at emerging-market countries suffering major crises, with an attitude of “it could never happen here”. Well, we’ve now learned, the hard way, that big crises can happen in the EU. The lesson must surely be that nothing is unthinkable.


Clearly, Mr. Salmon here has not done all his economic reasearch and it’s sensationalizing the real influence of the Chinese in the country. The US, continues to be the largest trading partner of the country, followed by South American countries (as a group). In this light, China’s influence is limited. Furthermore, the government is very aware of the potential of giving too much influence to China and has given preference to multilateral institutions credits. In the case of Cyprus, there is already not only economic, but also heavy political Russian influence in the country, much more so than the Chinese have in Ecuador. BTW – I’m NOT a Correa supporter.

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Why Ecuador isn’t drilling in Yasuni

Felix Salmon
Jan 2, 2012 15:27 UTC

Back in June 2007, I looked at an intriguing idea coming out of Ecuador, whose massive Ishpingo-Tiputini-Tambococha oil fields lie underneath the most important area of biodiversity on planet Earth: Yasuni National Park. (Time’s Bryan Walsh has been there. It’s worth reading his report to get a feel for just what’s at stake here; suffice to say that it’s a place which makes even grammar sticklers want to use the term “most unique”.)

Ecuador’s president, Rafael Correa, had a bright idea: instead of drilling for oil in the park, he would ask the global community to pay him billions of dollars not to drill in the park. $3.5 billion, to be precise, to be paid at the rate of $350 million a year for ten years.

On the face of it, the proposal has a certain amount of logic to it. The world has quite a lot of oil; it has only one Yasuni. And while Ecuador would get some desperately-needed cash from drilling for oil, the world would lose an area of paramount importance.

The problem is that we’re talking about Ecuador, here. What was there to stop Ecuador cashing the checks and then drilling for oil anyway? It’s a sovereign country, after all, and one which has reneged on many promises (a/k/a bonds) in the past. As Kevin Koenig puts it:

The proposal has been riddled with problems from the outset, many of them of President Correa’s own making. The proposal’s political and financial guarantees were slow in coming, which is problematic given Ecuador had seven presidents and two constitutions between 1996 and 2006, and defaulted on its Brady Bonds in 2008. Donor confidence was further eroded by several changes in the financial mechanism of the proposal, and frequent turnover of members of the negotiating team and foreign ministers who were the face of the initiative internationally. These factors, coupled with a series of Correa public outbursts and contrarian environmental policies, undermined the proposal’s credibility.

Nevertheless, the Ecuador Yasuni ITT Trust Fund was set up, under the auspices of the United Nations Development Group, and now, more than four and a half years after the original ask, Ecuador has proudly announced that it has managed to raise $116 million, which is enough of a down-payment that it won’t start drilling for the time being.

Obviously, the $116 million which has been raised by the end of 2011 is a far cry from the $1.4 billion that Correa originally hoped to have raised by this point. And if you look at the source of that $116 million, it’s even less impressive. $51 million came from Silvio Berlusconi, who deducted it from the money that Ecuador owes Italy — as though Ecuador was ever going to pay that money in any event. And another $40 million came from Correa himself, who donated the monster libel damages he extracted from opposition newspaper El Universo, in a suit that Amnesty International said “will have a chilling effect on freedom of expression in the country”. Which leaves just dribs and drabs from elsewhere: $100,000 from Turkey, $500,000 from Australia, that sort of thing. There’s no way that those sort of sums can ever hope to come close to replacing potential ITT oil revenues.

At the same time, Correa’s decision to declare victory and hold off on drilling for the time being is entirely rational. For one thing, there’s a lot of domestic popular opposition to the idea of drilling for oil in one of Ecuador’s two great national treasures of biodiversity. (The other, of course, is the Galapagos Islands.) It’s not that the population doesn’t want the money, but more that they’re very proud of the Ecuadorean Amazon, and very skeptical that if drilling does begin, that the proceeds would go to them rather than into the pockets of oil companies and kleptocrats.

On top of that, there’s a very real option value of not drilling for oil. It’s not like the oil is going anywhere, after all: no one else is in a position to drink Ecuador’s milkshake. Ecuador is retaining the option to drill — and that’s a valuable thing, which it loses the minute it actually starts drilling.

And the value of the option is only increased by the precedent set by the existing trust fund. Ecuador has done something important, here: it’s demonstrated that not drilling for oil is something valuable, and something which at least some of the rest of the world is willing to pay for. From here on in, it can continue not drilling for oil every year, getting rents for doing so all the way. Sometimes those rents will go up, and sometimes they will go down. But the more stable and trustworthy Ecuador’s governance, the more seriously its proposals will be taken. And, of course, if drilling starts in Yasuni, then all those future rents get thrown away forever.

Finally, there’s the fact that the reluctance of the international community to trust Ecuador in its oil-related dealings is mirrored by a similar reluctance on the part of international oil companies to enter into long-term contracts with the country. If you were ExxonMobil or Shell or BP, you would have a lot of very good reasons not to sign a contract to drill in Yasuni: you would be paying a lot of money up front, for a share of future oil revenues which could at any point be expropriated by a future government. And of course you would incur even more wrath from all environmentally-minded people around the world. You might not have heard of Yasuni now, but if Chevron started drilling there, I can promise you that you’d know all about it.

As a result, the ITT reserves would have to be drilled for by Petroecuador — certainly Hugo Chavez isn’t going to want Venezuela’s PDVSA to get involved. And Petroecuador is already giving all the money it can to the Ecuadorean government: it couldn’t find any more money just by starting to drill in Yasuni. In order for real money to start flowing, Ecuador would have to wait many years, for the wells to get drilled, the pipelines built (in the face of what would surely be massive opposition), and physical oil actually sold. Much easier to just collect millions right now, hope for much more in the future, and bask in the happy glow of knowing you’re doing the right thing by your national patrimony and for the natural wealth of the planet.

Oilfields, eventually, run out of oil. But untapped oilfields never do. Ecuador’s onto a good thing, here: it would be foolish to throw it away. Which explains why Correa isn’t drilling, despite the fact that he’s only received a tiny fraction of what he asked for.


A few months on, Felix and Nick, and yes, indeed it can be said that Rita was correct, though it’s only possible to state this in retrospect. In pardoning all the convicted journalists, Correa also obliterated the 40 million dollars in damages, which means the funds that *were* scraped together did not include that sum. The part about Berlusconi should still hold true, but it’s always best to verify your opinions beyond all doubt – despite this being a blog, or perhaps precisely because this is a blog under Reuters.

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How Ecuador sold itself to China

Felix Salmon
Jul 5, 2011 16:34 UTC

When a country is a serial defaulter, two things happen: it regularly writes down the value of its own debts, and it can’t borrow money anywhere else. The result looks something like this:


The implication of this chart is that Ecuador is finally, perforce, living within its means — something you have to do, if you have no ability to borrow.

Except there’s something the chart doesn’t show: China.

Ecuador’s government on Monday signed a loan for $2 billion with the China Development Bank Corp., Ecuador’s Finance Ministry said, as China deepens its financial ties with the South American nation…

Currently, China’s loans to Ecuador exceed $6 billion, including $1.7 billion to finance 85% of Coca-Codo Sinclair, a hydropower plant to be built by China’s Sinohydro Corp. in Ecuador, which will supply about 75% of the country’s energy needs.

In a country the size of Ecuador, these numbers are huge. The latest newsletter from Ecuador’s Analytica Investments puts them in perspective:

Since the 2008-9 default, which chopped the government’s foreign debt to $7.01 billion, debt has surged 54% to $10.78 billion with the latest deal…

Newspaper El Universo reported that the loan from China’s Development Bank is tied to another 72,000 barrels per day of oil deliveries, citing a memo from the negotiations. That would make Ecuador owe 75% of its oil exports to China, the paper cited opposition legislator Vicente Taiano as saying…

Ecuadorian bankers report that Ecuador wants a $10 billion credit line from China. If that were to happen, Ecuador would owe the Asian giant an extraordinary 24% of GDP.

With the latest deal, Ecuador owes China some $8 billion, or 19% of GDP. That’s more than its total external debt, as measured in the kind of charts which people generally look at when they want to know debt-to-GDP ratios.

This is something which happens when sovereigns default: they risk losing their sovereignty. Ecuador now resembles a wholly-owned subsidiary of China, much like many solvency-challenged yet resource-rich countries in sub-Saharan Africa. And a glance at Greece is enough to see how that country has essentially ceded much sovereignty to the EU.

Not all defaulting countries run into this issue: Argentina still does whatever it wants to do, and is beholden to nobody. But the oldest and loudest complaint about the IMF is that it forces governments to do its bidding in return for providing emergency financial assistance. And compared to the likes of China, the IMF is positively mild in terms of self-serving policy prescriptions. It’s a key reason why governments are well advised to address fiscal problems sooner rather than later. Because if they dally too long, they risk losing their very independence.


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Ecuador’s market manipulation: The WikiLeaks cable

Felix Salmon
Apr 28, 2011 02:08 UTC

I’ve posted on the subject of possible Ecuadorean bond-market manipulation in various places over the years, including roubini.com, felixsalmon.com, and portfolio.com as well as reuters.com. So it’s gratifying for me to see the subject come up in an official State Department cable, which has now been published by Ecuador’s El Universo newspaper in conjunction — of course — with WikiLeaks.

Here’s the relevant bit of the cable, was sent in June 2009 by US ambassador Heather Hodges, who has already been expelled from the country in the wake of the release of a different cable.

Market Manipulation?


3. (SBU) The repurchase of $2.9 billion worth of 2012 and 2030 bonds at a price of 35 cents on the dollar would represent a disbursement of about $1 billion. However, according to official figures, government reserves showed a drop of only $243 million between May 22 and May 29, the time the bond repurchase went through. This amount is much less than would be needed to repurchase the bonds, and lends credence to the widely held belief that the GOE repurchased some of the bonds previously in December 2008, following its report that the debt was illegitimate. An earlier purchase could have given the GOE an advantage by possibly reducing the number of remaining bondholders and their influence. Contacts from the Central Bank confirmed privately that the amount disbursed for the bond repurchase on May 29 was only $305 million.

SBU, here, stands for “sensitive but unclassified”; GOE is government of Ecuador. And the background, here, is the widespread belief that after Ecuador announced its bond default in December 2008, the government used Banco del Pacifico, a large Ecuadorean bank, to start buying bonds at levels above 20 cents on the dollar. That was just high enough that vulture investors didn’t want to amass a large position, but also low enough that buying bonds at 20 cents in the secondary market was a much smarter move than buying them back at 35 cents in the official restructuring.

There’s nothing particularly surprising here — the government’s intervention through Banco del Pacifico has been something of an open secret for a while. But it’s still startling to see it explicitly called “market manipulation” in a State Department cable. And it’s good to see State keeping an eye on such matters, which normally fall more under the purview of Treasury. A government which pulls dubiously-legal stunts like this is not one which can be trusted in diplomatic matters, so it’s good to see State paying attention. Not that they really needed to be told that the Ecuadorean government was prone to shenanigans.

Rhetoric and reality in Ecuador’s default

Felix Salmon
Jan 4, 2010 14:51 UTC

Every so often, my web browser will veer far enough to the left to find something like this — a heartfelt defense of Ecuador’s hugely-successful bond default which takes all the domestic political rhetoric at face value.

A lot of the article is simply confused: it frequently elides the distinction between foreign debt and total debt, for instance, and it was clearly not written by anybody who remembers Ecuador’s 2000 debt restructuring, since it calls that deal “unauthorized” when it was anything but. More generally, there’s lots of talk about Ecuador’s foreign debt being “unscrupulous” and “illegal”, not to mention “predatory and inhumane”.

This kind of rhetoric tends to go down well with Ecuador’s voters, but it really doesn’t stand up to scrutiny: if the concept of sovereign debt has any validity at all, then Ecuador’s foreign debt was just as legal as anybody else’s. Besides, given that Ecuador has dollarized, the distinction between illegal foreign debt, on the one hand, and presumably-legal domestic debt, on the other, is very thin: it’s basically just a question of governing law at this point. A decent liability-management office will quite easily play around with the proportion of a country’s debt issued under various different governing laws so as to minimize the country’s total debt-service bill. Certainly there’s no shortage of foreign investors buying domestic debt: do such instruments become illegal the minute that happens, especially if they carry a high coupon?

What Ecuador did in 2009 was essentially just a multi-billion-dollar version of what homeowners are doing in California: walking away from debts because it makes financial sense to do so. There’s always the possibility that any debtor will do such a thing — that’s the reason that credit in general, and Ecuadorean credit in particular, trades at such wide spreads over the risk-free rate. When the cost of default turns negative, countries — like any debtor — are liable to default. That’s simple economics. Trying to gussy that decision up in holier-than-thou rhetoric only serves to obscure the real mechanisms at work here.

I’m interested though to see that many people on the left feel the need to talk at length about the debt being illegal or predatory or whatever: it’s as though they too have bought into the idea that there’s a moral obligation to pay one’s debts, unless those debts are usurious. They don’t have a problem shafting foreign creditors, but they clearly do have an issue with the concept of default, unless it can be accompanied by some kind of moral justification. The economic benefits of defaulting aren’t enough for them: they need to carve out the moral high ground as well. They should beware such overstretch, though, because the moral arguments in this case are very weak: the debt was legal, and Ecuador had the ability to pay it. The only thing it lacked was the willingness to do so.


Dollared, you’re talking here about the doctrine of “odious debt”. There’s quite a lot of literature on the subject, and in the vast majority of it Ecuador’s bonds would not count.

Emerging-market debt after Ecuador

Felix Salmon
Jun 8, 2009 21:09 UTC

EMTA, the erstwhile Emerging Market Traders Association, hosted an in-depth session today on the debt markets in developing countries, both sovereign and corporate. And it’s the corporate bonds which are by far the biggest worry: emerging-market corporate loans are now five times the size of the corporate bond market. And JP Morgan’s Joyce Chang came out with one of the scariest sets of datapoints I’ve come across in a while. Get this:

  1. Total lending to emerging markets is now some $4.7 trillion.
  2. 74% of that was lent by European banks.
  3. Both Austria and Netherlands have lent more than 50% of their GDP to foreign developing nations.

It’s not just Latvia that’s in serious trouble: as Joyce said, a devaluation in Latvia could easily spill over to Bulgaria. At that point there are risks of 1997-8 all over again, only this time starting in Europe rather than Asia.

There was quite a lot of talk of how come the IMF and other multilateral institutions aren’t encouraging emerging-market countries in fiscal distress to reduce or attenuate their liabilities — there’s your answer right there. If emerging Europe started restructuring its debts, the pain in the EU would be enormous — and of course the G8 essentially controls the IMF and the multilaterals.

If the official sector is becoming friendlier to private-sector creditors, however, the big news today was the degree to which Lee Buchheit, the godfather of sovereign debt, has followed suit. Buchheit is an institution, both within Cleary Gottlieb, his law firm, and the sovereign-debt community more generally. He has represented dozens of sovereign debtors, and is known as the inventor of the exit consent — a tool by which countries can eviscerate the legal rights of minority bondholders. Up until very recently, he was considered by most private-sector bondholders to be the enemy; one of them described him to me once as an “evil genius”.

But Lee was singing a very different tune today, and unloaded with both barrels on his former client, Ecuador, and its president, Rafael Correa. Ecuador is a “rogue debtor”, he says, and its most recent default is pretty much the first time in 30 years that a country has defaulted without at least “a colorable claim to distress”.

Ecuador’s offer to its bondholders, said Buchheit, was “an extraordinary document unlike anything I’ve ever seen in this business”. Where most countries in distress at least pay lip service to the idea of wanting (just being unable) to pay, Ecuador repudiated its bonds outright, and said that it considered itself to have no legal or moral obligation to pay so much as a penny for them. That strategy was, no doubt, highly effective. But a large part of its success was due, said Buchheit, to the fact that the bondholders’ trustee — US Bancorp — “was bovinely passive” in the face of extraordinary provocation.

Buchheit did suggest that future sovereign bond issues will likely include clauses barring countries from defaulting and then buying back their distressed debt — not that such a clause would be remotely sufficient to stop a country like Ecuador which has little if any respect for international law. The bigger issue, said Buchheit, was those trustees. “What do you do to motivate the trustees to behave in an appropriate manner?” he asked, adding for good measure that “trustees are a species under the broader genus of invertebrates”.

One of the problems is that when trustees are chosen, they’re generally picked not on the basis of how hard they’re likely to fight for bondholders when push comes to shove, but rather on the basis of how cheap they are. But in general trustees are nearly always legally protected from bondholders, which means that if they take the easy and lazy way out and never kick up a fuss, they’re not going to be held liable for doing so. At the same time, of course, kicking up a fuss is an expensive and time-consuming thing to do. So there’s a lot of incentive to do nothing.

Buchheit was very worried about the consequences of Ecuador’s default. “Outliers tend to be infectious,” he said. “And once you establish a precedent, other countries and finance ministers will wonder why they should go through the tiresome business of negotiating with bondholders,” rather than just defaulting and buying back at pennies on the dollar.

Rafael Correa is no idiot. He has observed, said Buchheit, the tendency of the bond markets to forgive and forget much more quickly than bank lenders: “Financial markets today tend not to hold grudges the way that predecessor financial markets used to. So the traditional cost of a brutal restructuring is not one that they have to pay any more.”

And so, in the face of Correa’s provocation, Buchheit is speaking out. Most of his sovereign clients are keen to retain their access to the international capital markets; many of them are net creditors. So they no longer want their lawyer to stand up for sovereigns’ rights, so much as to repudiate actions by Ecuador which might well imperil their own ability to borrow money in future.

It’s truly a strange world, where distressed-debt investors like Hans Humes make nice noises about the IIF and formal restructuring mechanisms, while Lee Buchheit speaks out against “rogue debtors”. Might it be that out of this crisis is being forged a new consensus? I’m not holding my breath; these people almost never agree for long. But so many unthinkable things have happened already that nothing would shock me any more.


RTFA? Read the fine allegory?

Bovinely passive, just like State Street was in regards to Reserve Primary/Lehman?

Lessons from Ecuador’s bond default

Felix Salmon
May 29, 2009 21:05 UTC

EMTA, formerly the Emerging Markets Traders Association, had an interesting panel on the Ecuador default today. It was a bit lopsided: no one on the debtor side — and EMTA invited the country’s own representatives, as well as its lawyers and bankers, and even the US Treasury — would agree to attend. As such, it was really a panel of private-sector participants, and felt much like a wake: it was clear that with the success of Ecuador’s exchange offer, the country has won and the private sector has lost.

In the long term, of course, Ecuador might not have benefitted all that much from its antics: Erich Arispe, of Fitch Ratings, pointed out that the country is paying out much more in cash payments for its bonds than it would have had to pay over the next couple of years in coupon payments. On top of that, Ecuador is racking up lots of new debt to multilateral institutions like the Andean Development Fund and the Inter-American Development Bank, so even its fiscal position isn’t really improving.

But in the short term, Ecuador has elegantly managed to buy back a very large chunk of its debt at just 35 cents on the dollar. Old Ecuador hand Hans Humes, of Greylock Capital, summed up how spectacularly successful the Ecuador strategy was, calling it “one of the most elegant restructurings that I’ve seen”.

In hindsight, the deal could hardly have been done any better. First and most important was the matter of timing: as all the panelists agreed, there’s no way that Ecuador could have pulled this stunt in 2006 or even the first half of 2007. But the country was playing the long game: president Rafael Correa was elected president, on a platform which included debt repudiation, in January 2007; Ecuador’s clear intention to default on its debt earned it a pretty much immediate CCC rating from Fitch. Yet the default didn’t happen until December 2008, almost two full years after Correa’s election.

The wait turned out to be the best thing that Ecuador could have done, because in the interim the global debt markets were plunged into turmoil. And Correa didn’t pull the trigger until he could see the whites of his opponents eyes: he announced that he was defaulting on the 2012 global bonds at exactly the time that three huge hedge funds, which held Ecuador’s debt, were being forced by their prime brokers to liquidate their holdings. As a result, the selling pressure on Ecuadorean bonds sent them tumbling from the 70s to the 20s almost overnight.

They would have fallen further, into the waiting arms of a small army of hungry vulture funds eager to get back into the distressed-debt game after many years essentially being priced out of it. But then Ecuador pulled its next smart stunt: it used Banco del Pacifico, a large Ecuadorean bank, to start buying bonds at levels above 20 cents on the dollar. That was just high enough that the vultures didn’t want to amass a large position, and ensured that any future restructuring would face little organized opposition just because Ecuador’s bondholders were so fragmented.

Ecuador’s next clever step was to pay cash for its defaulted bonds, rather than trying to do a bond exchange. That meant that it didn’t need to go through a laborious SEC registration process, during which the legality of the Banco Pacifico stunt would surely have been questioned. And its final clever step was not to put forward a take-it-or-leave-it offer, as Argentina did, which would allow bondholders to agitate for a mass “no” vote. Instead, they just asked bondholders to name their price.

Of course that’s what the bondholders did. None of them wanted to be left as holdouts, given the ease with which Ecuador could change the covenants on the bonds, and also the fact that they hadn’t even managed to accelerate the 2030 global bonds by the time the default happened.

Joe Kogan of Barclays Capital said that bondholders’ inability to accelerate the 30s doesn’t just show a collective action problem. “It demonstrates that people weren’t really willing to hold on to the bonds, and that the original investors who had these bonds were trying to get rid of them,” he said: no one, in the present environment, had any appetite at all for litigation which could drag out for years.

No one expected Ecuador to pull this particular rabbit out of the hat. The country has a reputation for utter incompetence when it comes to fiscal matters, and a few months ago it fired its highly-respected and long-standing legal counsel, Cleary Gottlieb. Somehow, however, this exchange offer was probably the most successful and least fraught debt restructuring in the history of Latin American sovereign defaults.

The multilaterals played their part, by condoning Ecuador’s actions and basically taking its side, despite the fact that the country had no fiscal need to default. And Argentina, weirdly, helped too: holdouts there have got very little to show for their litigation to date, and indeed Argentina was found in contempt of court in New York this week for basically ignoring a judge’s orders to keep certain funds in the US. It was a legal victory for bondholders, but won’t help them get any richer.

And of course it also helped that Ecuador was so small. Even with the bonds at par, they accounted for only about 0.5% of the emerging-market index, which means that at this year’s prices Ecuador constituted about one quarter of one percent of a diversified EM portfolio. You could fight them, but when your portfolio is down 20% for other reasons, what’s the point.

Kogan was sanguine on the question of whether Ecuador’s default would spill over into other emerging-market sovereigns. Most countries with bonds outstanding have some kind of access to the bond market, he pointed out; Ecuador hasn’t been able to issue debt in years, so losing access was no big deal for Ecuador, as it would be for most other countries. Ecuador also isn’t going to suffer as much in terms of economic costs as other countries might — its corporations aren’t going to lose bond-market access either (because they never had access) and it’s not going to suffer a bout of hyperinflation, because it’s dollarized. And although the last Ecuadorean president to default did immediately get kicked out of office, this one was re-elected comfortably, so there aren’t the kind of political costs that you’d expect in other countries. The only real new costs to Ecuador might come in a few years, if holdouts manage to attach Ecuador’s oil exports in one way or another — but given the success of the exchange offer, there probably won’t be any holdouts, or Ecuador could continue to pay them their coupons, just as it’s continuing to pay the coupons on its old Brady bonds which weren’t tendered into the 2000 exchange.

Hans Humes, however, was more worried about Ecuador setting a precedent. “As much as we can say this is an outlier, any country which runs into trouble has a great blueprint now of how to do it,” he said. The last time Ecuador defaulted, it was reasonably constructive, at least in hindsight: it hired Cleary Gottlieb, a big financial-markets law firm, it entered into dialogue with creditors including the Dart family, and it was criticized in some quarters for paying too much to bondholders rather than too little. No one can accuse it of that this time around.

“The world has changed,” said Humes — we’re now living in a world where not only Ecuador can default, but Iceland can default as well. And that’s a world where defaults by small emerging-market countries simply don’t have the systemic consequences that everybody thought they might have. I even heard Humes say something I never thought I’d hear a died-in-the-wool buy-sider like him say: “Maybe,” he said, the solution to “go back to Anne Krueger’s model”

He was referring to SDRM, the attempt by then IMF first deputy managing director Anne Krueger to create a sovereign bankruptcy court. Not a single private-sector player thought this was a good idea, as far as I could tell, and certainly no one on the buy side had any time for the idea. But now, it’s clearly better than nothing — and nothing is what bondholders are ending up with these days. “The official sector’s already beaten us,” said Humes. If you’re going to capitulate to Ecuador, then capitulating to the IMF is easy in comparison.


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The cost of sovereign default turns negative

Felix Salmon
May 26, 2009 14:49 UTC

Ecuador has closed out its bond exchange offer at the higher end of expectations, paying 35 cents on the dollar to investors who hold the 2012 and 2030 global bonds. That’s higher than the bonds have traded all year, and certainly higher than they have traded since Ecuador defaulted — which means that any vulture investors who bought the bonds in default will be able to lock in a decent profit for doing essentially no work at all.

What’s more, Ecuador has announced that anybody who put in an offer higher than 35 cents will be allowed to re-tender at the 35 cent level. This makes sense from Ecuador’s point of view, and gives people who tendered high the opportunity to re-think their strategy in the light of known events. It’s pretty clear that at this level a supermajority of the total bonds outstanding will end up being owned by Ecuador — which means that Ecuador will have the ability to strip a lot of creditor protections out of the instruments.

Ecuador has suffered no negative repercussions from its actions — quite the opposite. If the country needs any money in the next few years, it’ll be able to get it, from the Andean Development Bank or the Inter-American Development Bank or the World Bank or even the International Monetary Fund. None of them seem to particularly care that Ecuador defaulted on its global bonds, and emerging-market bondholders are so weak and fragmented these days that they hold very little sway any more within international financial institutions.

Indeed, given the short memory of emerging-market bondholders, I wouldn’t be surprised to see Ecuador regain its access to the international capital markets within a few years, thanks to the way in which it has managed to substantially reduce its (already pretty low) debt-to-GDP ratio. That could well be the thinking behind the decision to remain current on the 2015 global bonds, which were issued when current president Rafael Correa was finance minister. Look, he’s saying: we pay back the money that we borrow. We just don’t pay back debt which was originally borrowed decades ago and which was restructured twice in a manner designed to be as friendly as possible to private-sector creditors.

Looking at this from a systemic perspective, it’s pretty clear that in this instance the cost of default, to Ecuador, was negative. That’s dangerous: it radically increases the probability of tactical defaults from all manner of other countries, including Argentina, Venezuela, and various African states. And once a wave of sovereign defaults starts, it’s very difficult to stop, since the cost of default drops with each new event. Right now the risk of such a wave is surely near a multi-decade high.


One of the interesting features of this default is the revival of the idea of different treatments accorded to different types of debt. There is a long history of such practice. The main purpose has always been to gain the short-term cost benefits of default without incurring the lont-term penalty of reduced access to the credit markets.

In this case, the regime treats its own debts as legitimate while treating those of its predecessors as illegitimate (or at least less legitimate). Eighteenth- century France used a different technique: treating previously defaulted debts as immune to further write-downs, while more recent debts were viewed as fair targets for default because their interest rates were, not surprisingly, considerably higher and could therefore be deemed usurious.

After the Napoleonic War, France finally became a reliable borrower, and one of the main demonstrations of this was honoring the Napoleonic debts in spite of the temptation to repudiate them. It was argued at the time that this was not merely a matter of good faith, but rather an unavoidable price for access to the credit markets on favorable terms as enjoyed by Great Britain.

To my mind, this remains a valid argument. Historically, default almost always had a negative short-term cost – it certainly did so on for France before 1815. The regime always had access to new loans after each bankruptcy; but its access to credit was limited by its previous track record. Attempting to justify its actions by differentiating between types of debt did not fool creditors. They may have continued to lend, but always at rates that factored in the risk of default, and in amounts considerably lower than they were willing to lend to Great Britain.

Just because Ecuador currently experiences a short-term gain will not turn it into a good credit risk. Only paying debts regardless of short-term incentives to default will remove it from the vicious cycle of borrowing and default which has mired Ecuadorian (and Latin American) history since liberation from Spain.

Posted by James Macdonald | Report as abusive

Where are Ecuador’s bondholders?

Felix Salmon
May 19, 2009 19:35 UTC

According to Ecuador’s finance minister — and there’s no reason not to believe her — there’s been “excellent” take-up of her offer to buy back Ecuador’s 2012 and 2030 bonds at somewhere in the neighborhood of 30 cents on the dollar. As Reuters’s Maria Eugenia Tello notes,

Most holders of defaulted debt have so far failed to create a united front against Ecuador to seek repayment via courts.

This is in contrast to what happened the last time the Ecuador defaulted, in September 1998. Back then, Ecuador made the announcement in the middle of the annual meetings of the IMF in Washington, and substantially all of Ecuador’s bondholders were in the same place at the same time. It didn’t take long for them to organize meetings and reject Ecuador’s offer to pay some bonds in full while in other cases using the bonds’ own built-in collateral to keep current.

Why do bondholders seem to have lost cohesion over the past decade? At the time, I thought that the experience of Ecuador’s 1998 default was going to be the event which catalyzed bondholders to come together as a much more unified bloc — and indeed the Emerging Market Creditors Association was formed as a direct result of the way that the Ecuador default was handled.

But EMCA fell apart, nothing really took its place, and a major global financial and economic crisis kinda took the wind out of bondholders’ sails. At this point, most of them have neither the energy nor the time horizon nor the levels of capital needed to rally and fight — Ecuador’s timing, you could say, is perfect in that regard.

What’s more, any holdout strategy is fraught with risk:

Many market watchers on Wall Street say Ecuador has a key advantage because Correa had already bought back most of the debt when the country started to threaten a default and dragged down market prices in late 2008. Ecuador has not confirmed or denied past buybacks.

The point here is that if and when Ecuador controls a supermajority of the bonds — which it certainly will by the time the exchange is over, if it doesn’t already — it can start modifying a lot of the covenants in them, making a court fight that much more difficult. Most hold-out or “vulture” creditors tend to dislike litigating bonds in any event, preferring loans instead, which tend to have stronger covenants.

So if there are any hold-outs, their best hope will be that they’re in a tiny minority, and Ecuador just does what it did last time, and pays them off in full because it’s easier and cheaper than fighting them in the courts. But the hold-outs would probably need to amount to less than 4% of the amount issued before Ecuador went down that route.

Will there be 96% takeup of this offer, including bonds Ecuador already owns? It’s possible, but I suspect that there will be enough too-high bids, in the 40-cent-and-over range, to stop that from happening. In which case Ecuador’s holdouts will find themselves in much the same position as Argentina’s. Which is to say, an unhappy position indeed.


Felix your note are very good
wright more please

Posted by daniel | Report as abusive