Jay Newman was a senior portfolio manager at Elliott Management and author of the financial thriller Undermoney. Benjamin Heller is a portfolio manager at HBK Capital Management specializing in emerging markets.
The world of troubled sovereign debt seems to attract bad ideas like no other, generated mostly by the bureaucrats of the G20 and the International Monetary Fund.
The most recent is the Common Debt Treatment Framework, which is neither general nor a framework, but rather a recapitulation of the ad hoc nature of the sovereign default resolution process. Twenty years ago it was the Sovereign Debt Resolution Facility, a Trojan horse to create a sovereign 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 bails out badly governed, corrupt countries from their debts without generating growth, strong domestic institutions or even permanently clean balance sheets.
We also have the IMF and the G7 to thank for the creeping loosening of collective action clauses, shrewdly turning them from a tool to facilitate organized restructuring into a poison pill that renders sovereign debt functionally unenforceable.
But the granddaddy of bad ideas is the so-called Brady Plan, a trick that—if it hadn’t been designed and blessed by the U.S. government—would have landed many people in prison for accounting fraud.
Simply put, the Brady plan bundles outstanding and troubled junk government debt with long-term, zero-coupon US government bonds. The express purpose – the only purpose – was to enable otherwise insolvent Western banks to avoid recognizing huge losses on their developing country debt portfolios. 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 . . . Nothing.
Ironically, after the new bonds left the banks’ balance sheets, bondholders and issuers spent much of the late 1990s and early 2000s unwinding collateralized Brady — and sharing in the considerable profits available from the unwinding of a structure that both sides found economically inefficient.
Now two experts on complex financial and legal structures, Lee Buchheit and Adam Lerick, are proposing to recycle the Brady plan. The FT’s Martin Wolff 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’s a fair point. But whether, as he concludes, this “mainly reflects the 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. Last but not least, it offers the creation of the kind of structural complexity that only a quantitatively oriented hedge fund trader could like.
In other words: “this proposal will convert all debt. . . into 25-40 year debt,” which “should reduce the net present value of the debt by more than 50 percent and put the debt on a sustainable path.” This reduction will be achieved by offering bondholders a “cash down payment” financed by new zero-coupon loans from the World Bank and the IMF.
Of course, the World Bank “can use derivatives to transform . . . zero coupon in standard . . . floating rate liability.” Then there is what is called a maintenance floor structure that will allow the debtor to magically pay off these new debts 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 are not accompanied by a clear purpose. As for the results, there will be lots of new tools for well-paid hedge funders and bankers to divvy up and lots of new money flowing through the system. But how the plan will solve all the real problems is a mystery.
So many of these “big” ideas have been generated by or on the backs of international institutions. Inevitably, they are solutions in search of problems that would be better addressed directly. It is a shrewd intellectual precision to conflate insolvency with a “debt problem” — as if the debt burden had landed on the country unbidden like an alien spaceship.
Is the problem only debt? Or the complete failure to mobilize fiscal resources? Or poor management of these resources? Failure to create a favorable environment for growth? It’s strange to think that – to take a random example of a country talking about a possible debt restructuring – Nigeria needs a debt write-off, but nothing should be done about the fact that the country is mobilizing 6 percent of GDP in tax revenue.
Another current development is the case of Sri Lanka: the IMF, as always, is intent on imposing its own view on debt sustainability. It is high time that lenders came up with their own sustainability metrics, much in the way that banking advisory committees did in the 1980s. Unlike the IMF, private lenders would propose actual standards for fiscal effort and reject sandboxed growth trajectories based on the soft fanaticism of low expectations.
What never comes up in the countless conferences on sovereign debt or in the research and discussions led by the official sector are the root causes of sovereign debt defaults: corruption, weak governance and domestic institutions, refusal to waive loans in foreign currency and the failure to prevent theft, much less to recover ill-gotten gains.
On some level, Buchheit and Lerrick understand that serial defaulters have problems that go beyond the simple existence of debt. The only sensible part of their proposal calls for structural restrictions on the ability of borrowers to reorient themselves to new loans after going through their neo-Brady Rube Goldberg machine. They know better than to put a non-treating alcoholic next to an unlocked liquor cabinet.
Yet for the formal sector, poor fiscal performance, poor political governance, and attendant public debt problems are more of an opportunity than a problem. After all, the problems are theirs reason for existence.
Countries are mostly poor because they are poorly governed by a political class that aims to collect rents rather than provide honest services. Fancy templates, frameworks, initiatives and plans ignore the root causes of human misery resulting from this bad behavior. They are misdirected, solve nothing, obscure the underlying problems and absorb attention that could otherwise be productively directed at solving them.
