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- [00:11]
A
Hello and welcome to the Cryonics special edition of Slate Money, your guide to the business and finance news of the week. I'm Felix Salmon of Axios, and there's only one thing I really care about in this world, which is sovereign debt. We all know this. Long time listeners of Slate Money will know that I'm obsessed with all things sovereign debt, especially Argentina. Anna Shymansky and I, when we first met, we basically just nerded out about sovereign debt. For how long?
- [00:46]
B
It was like over an hour.
- [00:48]
A
There was like I was trying to talk to Anna to try and work out whether, like, she would be a good host on Slate Money. And I totally failed to do that because all we did was nerd out about sovereign debt.
- [00:57]
B
Tuna bonds.
- [00:58]
A
Tuna bonds. We have to talk about tuna bonds. So this is, I'm, I'm very, very excited this week because not only is Mitu Gulati of Duke University here in the studio with us. Mitu, introduce yourself. What's your like, claim to fame?
- [01:16]
C
I tag along with Lee and you since we met, I think 17, 18 years ago in the context of Ecuador. And I've tagged along with the two of you in every sovereign debt restructuring since.
- [01:29]
A
And wait, who is this Lee person?
- [01:32]
C
This Lee person is the person who has basically brought pain and suffering to creditors all over the world, although I think he would say in a highly benevolent fashion for now three decades.
- [01:50]
A
Mr. Lee Bukait, the doyen of the sovereign debt world, you're pretty much the senior partner at Cleary Gottlieb.
- [02:00]
D
A senior partner.
- [02:01]
A
A senior partner at Cleary Gottlieb. And as I reminded by Max Jacobs, the producer of Slate Money, the author of how to Negotiate Euro Currency Loan Agreements, which I honestly, I have a copy of. It's not easy to find, but Lee was kind enough to send me a copy. It is inscribed to me by Lee and it is the funniest book about euro currency loan agreements you will ever read. It is full of wit and awesomeness. So if you ever feel the need to negotiate a euro currency loan agreement, do find yourself a copy of this book. But Lee, we were just running down the list of just the Caribbean sovereigns that you've represented, and it seems to. And we kind of left a few out because there were so many. You have spent decades representing sovereign debtors, especially when they run into trouble and need to renegotiate their debt. And so this is going to be the entire episode because we have so much to talk about. I'm very excited about this, but. And I think the, the best way to do this is that we're going to talk about past, present and future. We're going to start off talking about some of the great war stories from the past and then we're going to talk about the present day defaulted borrowers who would be Venezuela and Puerto Rico. And then we're going to talk about the future defaulted borrower. There's a very, very large one who looks like at some point it might wind up defaulting and if it does, could basically cause cataclysmic consequences for the planet. So that's the plan. But who knows? It could go horribly wrong because you never quite know where these things are going to go. But yeah, let's start at the top. How did you, like, where does this begin, this story? I mean, I guess sovereigns have been defaulting since time immemorial. But when did they start renegotiating their debt?
- [04:14]
D
Yes, in the modern era, it began in August 1982. What happened was you had dozens of what we now call emerging market countries who borrowed billions of US dollars on the syndicated loan market, all of them Libor based loans. And in 1981, Paul Volcker raised interest rates to the point that Libor topped out at 22% per annum, which rendered all of these countries essentially insolvent.
- [04:48]
A
Not to mention Citibank.
- [04:50]
D
Well, that was a deep concern both of Citibank and of the US treasury at the time. But that forced all of these countries to begin restructuring in that era, the 1980s, early 1990s, there were 24 or 25 countries in the process at the same time.
- [05:09]
A
And they all went into default more or less at the same time. And they all came out of default with this thing called the Brady Plan. Is that more or less it?
- [05:20]
D
That's more or less it. At the time the crisis began, many of the large international banks were so wildly overexposed to these countries that had they actually defaulted, that is started missing payments, it would have brought down the international banking. Therefore, the technique of that era was the banks were told to reschedule, rollover the principal of the loans. They were told to lend the countries the money needed to pay the interest on the old loans.
- [05:58]
A
This is the extend and pretend.
- [06:00]
D
Exactly. And for seven years, bank examiners were whispering in the ears of these institutions that they should be putting money away against a rainy day. Even though the propaganda of the time was that no bank will ever take a loss on its sovereign portfolio. The propaganda was that all of these countries would somehow grow out of the debt Crisis. And I can tell you the favorite Mexican joke if you wish.
- [06:33]
A
But two, tell me the favorite Mexican joke.
- [06:36]
D
Well, if you've really got time. So the joke is that the Mexican Minister of Finance is sitting next to the US Secretary of State at dinner. And the Secretary of State says, Mr. Minister, we in the United States are extremely interested in how you're going to deal with your debt crisis. And the minister says, Mr. Secretary, I'm glad you asked. We have two possible approaches. One of them a very hard headed business kind of approach to it. The other one, even we Mexicans think is a little more what you Americans call pie in the sky. And the Secretary says, I'm delighted to hear that, sir. What is the hard headed business approach? Aha, Mr. Secretary, under that theory, there are roughly 75 million Mexicans. We will all go to the shrine of Our lady of Guadalupe, we will kneel down and we shall pray that the debt crisis is lifted from us. And there's a long pause and the secretary says, Mr. Minister, sir, with respect, if that's the hard headed business approach, praiser, what is the pie in the sky? Ah, Mr. Secretary, under that theory, Mexico will adopt an IMF program, reschedule its debt and grow out of the debt crisis. There, there's the joke.
- [08:00]
A
There's the joke which it didn't do.
- [08:04]
D
Well, what, what happened?
- [08:05]
A
It failed to do that.
- [08:06]
D
Seven years after it all began, new Treasury Secretary Nicholas Brady gives a speech in March of 1989 in which he said, we cannot continue to do this. In theory, it could have been done in perpetuity as long as the banks continue to lend the countries the money to pay the banks the interest. But he said, this is madness and you're going to have to write off a portion of this debt. The bank's immediate reaction to that was if we're going to have to write off any portion of this, we want to turn all of this old syndicated loan debt into bonds so that we can sell those instruments to a market. The institutional investor community, non commercial bank investor community that had escaped the 1980s without any memory of being restructured.
- [09:07]
A
And this was the real genius. Somehow if you turn the debt from being a loan into being a bond, it automatically goes from being this nasty, rolled over, no one wants to touch it with a 10 foot pole piece of toxic paper, to being a pristine and beautiful. Never has any country ever defaulted on its sovereign bonds and it's totally safe and a whole bunch of investors around the planet will want to own it.
- [09:35]
B
Alchemy is real.
- [09:36]
A
It's amazing.
- [09:37]
D
Well, that illusion persisted for the better part of a decade. The bond communities had. Sovereign bonds were not restructured in the 1980s. Why? Because they were precious few of them. I mean truly negligible. And the bondholder community somehow interpreted that history as, as saying that bonds were a senior instrument. Inviolable was the. I did a little survey in the mid-1990s when these countries had come back to the bond market and I read the prospectuses. Every prospectus in that era had some version of this sentence. While the Republic of Ruritania has for the last 12 years repeatedly restructured its commercial bank debt, its bilateral government debt, its trade debt, its interbank lines, the Republic of Ruritania has punctually and in full paid all of its bondedness. Now, it was it's delightful sentence from a lawyer standpoint because it is both true and wildly misleading. It was true the bond dead was paid, but it was only paid because it was so utterly negligible. And once these countries had converted their old bank loans into Brady bonds and returned to the Eurobond markets, it was only a matter of time before a sovereign was going to have to restructure its bond indebtedness. And that time arrived at the end of the decade, in the 90s, 1999, Ecuador, which you well remember vividly, Pakistan and Ukraine restructured their bond indebtedness. And roughly a year later in 2001, Argentina restructured plus or minus US$80 billion of bonded deadness.
- [11:44]
A
So Argentina was, was the big one. Ecuador, I remember vividly, I remember, you know, I followed it from beginning to end and when it defaulted, everyone said, okay, this is impossible. Loans, you can get your bank lenders around the table and you can have a negotiation and you can persuade them to do something. Bonds, you can't do that. You don't even know who your bondholders are. And there's a gazillion of them all over the planet. And so you can't have a negotiation. And in any case you need unanimity from them. And, and the whole point of the conversion from loans to bonds was to make these things impossible to restructure. That's why everyone bought them, because they were impossible to restructure. They cannot be defaulted. So now that you've defaulted on them, it can't be done. And yet somehow, through the magic of exit consents, which I think is maybe too nerdy even for us to go into.
- [12:46]
B
Oh no, I think in Venezuela we're going to talk about exit consents.
- [12:50]
A
There was this Amazing magical thing which you kind of invented called the exit consent. And you managed to essentially through a few sticks and a few carrots, get Ecuador's debt restructured. And everyone kind of said, wow, that was unexpected. So and then Argentina happens and having, and having then at that point gone through Ecuador, gone through Pakistan, gone through Ukraine. I guess people knew that it was possible to restructure debt at that point. But Argentina didn't exactly go as smoothly.
- [13:34]
D
No, I was not involved in Argentina in those days. I was on the other side of a Chinese wall. My firm was involved. And Argentina, you remember, had a major political crisis at that time. They defaulted in December of 2001, but did not get around to restructuring that debt until 2005. Now that in this line of work is an impossibly long period. Normally between the time of the default and the time you close a restructuring, you want that to be as short as possible because it's going to be utter chaos in the country while it's going on. There'll be no investment, trade will be affected. Et the Argentines had a political crisis and so they took an unusually long time. And during that period, the debt traded into the hands of hedge funds and investment vehicles, some of whom brought lawsuits. So that when the restructuring actually happened, you were dealing with a debt stock composed of creditors, some of whom, many of whom had actually pursued legal remedies, paid lawyers, gotten judgments, and that makes it a less tractable debt stock.
- [14:52]
A
In other words, while restructuring bonds is something which you kind of had the technology, you kind of worked out how to do it, restructuring judgments is tougher.
- [15:05]
D
It's tougher for a couple of reasons. One is the judgment separates the claim from the underlying bond. So techniques like exit consents can't be used to encourage a judgment creditor to come in. Also, the judgment creditor is sitting there saying my pistol is now loaded. And by the way, it's cost me X dollars in legal fees to get to this position. Why should I surrender it like one of the creditors that never bothered to try to pursue their remedies.
- [15:42]
B
So after this decades long saga that Argentina had, what effect has that had on new sovereign debt contracts? Are we seeing a lot of changes or is the kind of conservative nature of the underwriters making a lot like stopping a lot of those changes from happening?
- [15:58]
D
No, Argentina left some residual scar tissue in the international bond market, particularly in two areas. One is this Paris Passu clause that you mentioned, which the New York courts in Argentina had interpreted to say that Argentina could not pay one type of creditor without paying another. That was a fallacy when they first articulated it. Since the settlement in Argentina, the New York courts have been disowning the fallacy and correcting it. So the other area is in what are called collective action clauses, provisions in a bond which allow a super majority of creditors to restructure it with the result that they sweep along any dissenting minority.
- [16:53]
A
Ultimately, in Argentina, it seems to me that what you're saying is that the problem was not the pari passu clause and the problem was not the lack of collective action clauses. The problem was political and domestic.
- [17:04]
D
I think that's what historians will conclude.
- [17:07]
C
I mean, Argentina, looking back, I think if the country and its lawyers had been able to, or willing to, and we don't know the story for why they didn't use exit consents in 2002 or late 2001, we would never have been in this situation where you had them passing a law, the law that caused all of the pari passu problems. But that's all in hindsight. In 2001, late 2001, the techniques that had been used in Ecuador were perceived by many people, I think at that point as crazy, nutty, outrageous, as you had probably written about. And I suspect that people at the Ministry of Finance in Argentina said, you know, we're no Ecuador, we're going to do this in a sensible fashion and we will settle with everybody and we will put pressure on them and we'll fix this on our own without the need for those kinds of techniques. And they paid an incredibly heavy price for that strategy.
- [18:19]
D
Bear in mind too that when Argentina launched its restructuring, it did not have an IMF program. And so, unlike virtually every other case we're going to talk about this morning, when Argentina went to its creditors with a pretty savage restructuring proposal. It involved more or less a 75% net present value write off of the value of the claim. There wasn't an independent party like the IMF who could vouchsafe to the creditors that yes, indeed, this restructuring was necessary. And indeed the amount of debt relief being requested is proportional to what the country needs, not just what the politicians want. And absent that, there was a degree of skepticism in the bondholder community about the restructuring proposal. And it resulted in 2005 in a holdout population, a non participating population of roughly 24%, which is enormous in standard.
- [19:35]
A
Is like less than 5%, right?
- [19:37]
D
Yeah, yeah. That's what you aim for. Yeah.
- [19:41]
A
Moving on to the present, I want to ask you about something you said with respect To Argentina. You said that after it defaulted, normally what you would do is immediately try and do some kind of restructuring. You would do that within months. And the reason why you would do that within months, not wait four or five years, is because being in default causes a world of pain. There's a huge massive cost of being in default and you need to sort of get out from under that somehow. So can you explain there are two countries in the world right now which are sort of famously in default. Well, one country which is Venezuela, and one sort of quasi sovereign entity which is Puerto Rico. And both of them defaulted and neither of them, it strikes me, are in a worse place for having defaulted than they were pre default. So what is the difference there?
- [20:49]
D
Well, Venezuela, that's a man made crisis. That's the product of 20 years of grotesque economic mismanagement and corruption. It is potentially a very rich country. They sit on the largest oil reserves in the world. The 95% of their foreign currency earnings comes from the sale of oil oil. But that has been mismanaged and the oil exports decline. Literally. They have had to divert the money that they were using on imports for food and medicine and so forth for a very long time. They continued full servicing of their external debt at a terrible cost to the local population. They have now, since last September, defaulted on most of the series of bonds. And that is saving them some money. But with oil production declining as it has, it has not been a salvation of the country by any means. The US government imposed sanctions on the country in August of 2017. Those sanctions effectively prevent a consensual restructuring of the kind that all of these other countries have done.
- [22:11]
A
For one thing, no bank will sign up to advise Venezuela so long as these U.S. sanctions are in place.
- [22:17]
D
Yeah, and U.S. bondholders could not participate in a restructuring without a license from the US treasury, which I don't think will be forthcoming. So essentially the scenario now is that there must be a regime change with a successor regime that is acceptable to the international community. If that happens, then I think you will see very quickly the official sector, the imf, World Bank, Inter American Development Bank, US treasury, having to come in with a huge amount of immediate financial assistance just to arrest the humanitarian crisis. And a debt restructuring will follow that. But if you ask, when might that happen, the answer will depend on your belief in the efficacy of prayer.
- [23:16]
C
So let me turn Felix's assertion that default hasn't been that costly around, I think, and maybe Lee and Anna can tell me that I'm wrong, but I think that actually Venezuela, when the restructuring happens, will be in a much worse position than Argentina was, believe it or not. And I don't think Puerto Rico is benefiting from this long time period where they go into default and then just don't seem to be able to do much in order to get out and get back to the markets. But Venezuela, in the period of time since they haven't been able to borrow, has, in order to keep themselves running, been indulging in all sorts of under the table financing. And my sense is that when they come to the table and when the IMF people have to go in and look at what kinds of debts there are, they are going to find all sorts of creepy crawly creatures there that are very difficult.
- [24:22]
A
Is it the Chinese creatures?
- [24:23]
C
No, in fact, I think the Chinese ones are not going to be the worst of them. I think you are going to have very sophisticated people who have lent to them under the table in the kinds of agreements that Lee would find very hard to restructure that will not have any loopholes. And I've seen some of this documentation and it is intended specifically for the clever restructure not to be able to get through.
- [24:52]
B
Yeah, because I think this is really important because when you're talking about the Venezuelan context, we often talk about the Venice Sovereign and the pdvesidet, but there are all of these other creditor claims, the bilateral loans, the exit arbitration claims, those like airline boulevard deposits. I mean it's a significant, it's almost as much as the, just the bonded debt.
- [25:12]
A
And we saw. And of course Lee of all people knows about that because you did Greece, which again had like how many different borrowers were you trying to restructure there?
- [25:24]
D
Well, Greece had one great advantage, the debt, something north of 300 billion euros in, in 2012 was bond indebtedness. The problem with Venezuela, as Anna has just said, is that you have an extraordinary diversity of types of creditors, as did the. The best analog is Iraq in 2004. Me too. And I have concluded in our own discussions that conventional sovereign debt restructuring techniques of the kind that we've been employing for the last 30 some years probably will not produce a happy outcome in Venezuela and that something different is going to be needed in this case if and when a regime change occurs.
- [26:20]
A
Okay, so let's talk about cryonics.
- [26:23]
D
Well, it wasn't actually cryonics. Cryonics was the idea was this. Normally in a sovereign debt restructuring, when you take bonds back in, in an exchange with existing creditors, normally you cancel them because you don't want to double your debt stock. Obviously the problem with that, as Argentina found, is that any holdout bondholders may later on come and claim that if you're going to pay the people who entered the restructuring, you should be paying them too. And one way of potentially thwarting that was to keep the bonds that you take in legally alive. So they have a pulse but don't represent a threat to you. You put them in the hands of a trustee. We called it the cryonics solution. Cryonics is a science of freezing human bodies or body parts until such time in the future as there is a.
- [27:25]
A
As you say, that doesn't work in Venezuela because it's not mostly bonds that are the problem.
- [27:29]
D
Well, you could do this with the bonds, but the arbitration award holders are not subject to this. The folks with blocked Bolivar deposits are not subject to it. So that was our solution was our thinking was that to deal effectively with Venezuela is probably going to require some official sector intervention. There are a couple of precedents for this. The most obvious one is Iraq. In 2003, post Saddam, the UN Security Council passed a resolution which immunized Iraqi oil assets, which is most of it worldwide, from any form of creditor attachment. And they did that under what's Chapter seven of the UN Charter, which makes it binding on every member of the United Nations. What that meant was that Iraq could approach the restructuring of the Saddam era debt stock, roughly $140 billion, where it confronted its creditors and said, you folks can sue us and get judgments, but those judgments will convey an emotional satisfaction, not a financial satisfaction, because our assets worldwide are clothed with this immunity in the face of that, that tends to soften up the beaches with creditors. And Iraq got its pretty stiff debt restructuring OR amounted to 89.75% net present value write off of the debt stock. But the issue with Venezuela is if you wanted to walk that path, you'd have to persuade the Russians and Chinese on the Security Council to support it.
- [29:27]
A
So the reason why Venezuela was so keen to not default and was letting its citizens starve rather than default was precisely this issue that the minute they defaulted, the bondholders would swoop in and attach CIDSGO and Perevoza and all of these assets all over the world. And they and that was unconscionable. Eventually they did default. And did that happen?
- [29:55]
D
No. The bondholders have thus far shown considerable forbearance. But the issue is that the arbitration award holders have successfully attached assets and it appears forced settlements. And the bondholders are right now in A position where they are thinking that the arbitration award holders have stolen a march on them. And so I think we will see possibly by the end of the year that some of these bonds will accelerate and become judgments.
- [30:37]
B
Yeah, it was interesting because didn't they just, didn't Venezuela just pay a coupon and amortization payment on one of their Pita Vesa bonds specifically because it was tied to Citgo and they were very concerned about bondholder activity?
- [30:49]
D
Yes. One of the bonds maturing in 2020 is collateralized by a pledge of 51% of the shares of Citgo, which is the jewel in the Petavasa emp. And they have made the principal and interest payments on that to stop a foreclosure on those. But all the rest are in default now.
- [31:20]
A
So let me move to Puerto Rico, because what you're saying in Venezuela is that ultimately this is what we're going to have to have is a humanitarian intervention which will then lay the groundwork to allow some kind of a debt restructuring in Puerto Rico. Kind of exactly the same things happened. Obviously, the default happened before Hurricane Maria, but it wasn't that long before we then had this devastating hurricane. We then had a humanitarian intervention in the form of, you know, however you want to calculate it, billions of dollars of FEMA money coming into the country according to one piece of paper that is going around, it is going to work out in total to about 82 billion. And because of that $82 billion, the bond prices have rallied and people have said, well, great, this humanitarian intervention is actually going to set the stage for a relatively generous debt restructuring, which has very much annoyed the President of the United States, who says, well, wait, hang on a sec, this just means that the humanitarian intervention is going to pay off bondholders. Is he right about that?
- [32:35]
D
I. My suspicion is that the US Government, the current administration, will not want to see any of that money bleed out to pay what they will call legacy creditors. Puerto Rico is special because it is not a sovereign, so it is not Argentina. But by the same token, it is not a municipality subject to the U.S. bankruptcy code. And so Puerto Rico has the great disadvantage that it is both geographically and legally halfway between Detroit and Buenos Aires. And Puerto Rico tried but failed to have a consensual restructuring of its debt and in the end had to turn to the US Congress for legislation that would protect it, but in that process had to effectively surrender their fiscal sovereignty.
- [33:43]
C
Yeah, I mean, for me, Puerto Rico is one of the most horrific examples of debt restructuring going wrong in that Puerto Rico, like Greece, and maybe we can ask Lee about this, but Puerto Rico, like Greece, had all of its debt governed by local law initially in the crisis. And there were a variety of techniques it could have used to really write down the debt seriously. And creditors understood this and I think would have come to the table. But some combination of bad advice from whatever hedge funds were talking to them or good advice from the hedge fund's perspective and bad government resulted in them deciding that they didn't want to do a harsh restructuring early and they just wanted to delay. And the delay ended up then in some half assed attempt to do a bankruptcy procedure that I think good lawyers would have told you could not work, at least was very high risk, that failed miserably. And now we're still in this morass with this control board whose legality is still uncertain. I think December 3rd, there's going to be a hearing in the first circuit in Boston about whether or not the control board is even legal. And so this is just. Puerto Rico is just going on and on and on and cannot get back to any kind of economic growth.
- [35:18]
A
And to my original question, how much damage is being done to Puerto Rico and its economy over and above the damage from the hurricane by the fact that it is currently in default?
- [35:31]
C
I think enormous damage. And I think the biggest damage perhaps is the large number of young Puerto Ricans who, because of Puerto Rico's inability to effectively grow, are leaving and moving to places like Florida.
- [35:46]
A
And why is it harder to grow when you're in default than if you're not?
- [35:50]
C
Well, investment. Investment is not coming in and you can't go back to the markets now. You know, my hope is that they'll give them statehood. Congress will recognize that you need to give them statehood. And we know the historical evidence on statehood for places like Hawaii and Alaska has been that that is a huge spur to growth. And maybe that's one avenue by which Puerto Rico can actually get resuscitated. But currently there isn't any talk of that or meaningful support for that in Congress.
- [36:28]
D
This is one of the hidden costs of sovereign debt crises. Puerto Rico is unusual because all those folks have US Passports and can come to the mainland very easily. But even in countries that don't have that advantage, you will often have the best and the brightest emigrating. They will simply have job opportunities abroad. The cost to a society of having a generation of young people exit, you can never quantify that cost.
- [37:12]
A
You can't. But I guess you can similarly dispute the degree to which it's a function of debt default. The best and the brightest were leaving Puerto Rico long before it defaulted, just as they are leaving Portugal and Spain right now. So you don't need. I guess my question is how do you draw that line from the default to the brain train?
- [37:36]
C
You're undoubted.
- [37:37]
D
No, no, it is the contraction of the economy.
- [37:41]
A
And how do you draw the line from the default to the contraction of the economy, which similarly was contracting even before the default?
- [37:48]
D
To be sure. But in most of these countries, the IMF will be called in. The IMF has a very simple playbook. They will say you've got to raise taxes, you've got to cut your pensions, you've got to reduce the public sector payroll. All of these things will cause, at least in the short to near term, an economic contraction. Greece, let's stay with Greece for a minute. Unemployment rate among people 25 years and older has been for a decade above 50%. 50% unemployment rate generally has been at depression, what we Americans would think of as depression era levels, 25 to 30%. And this thing is now going into its first decade. But, but 20, 30, 40 years from now that society, a society undergoing this process will pay a price because the leaders in their political, professional, commercial life will have gone. My point is that it is ultimately unquantifiable, but surely a significant cost of one of these affairs.
- [39:17]
B
Right? Because in Greece, even though in Greece they were eventually able to deal with the debt, there was a relatively significant haircut, there was such a delay in getting the private sector involvement, and it just seemed like the entire process has been so slow. And it goes back to also this idea of trying to like grow out of your debt in a way that does seem like a fantasy that people are still holding onto.
- [39:37]
D
Yes, well, the theory among some of European officialdom, but particularly the European Central bank when the Crisis started in 2010, was that there must never be a debt restructuring, a sovereign debt restructuring in Europe. The result was that the official sector, the EU and the imf, had to pour hundreds of billions of euros into Greece, most of which bled out just to repay in full maturing bonds. They came to regret that decision in 2012, but it lasted for the better part of two years. And it was the policy followed in Portugal, in Ireland, in Cyprus.
- [40:23]
B
And doesn't this also go back to this fear of the connection between the sovereign and the banking sector?
- [40:27]
D
Yes, very much. Very much. One problem that you have in Europe, in some countries more acutely than others, is that the banks are allowed to hold debt Obligations of Eurozone sovereigns with no risk, no need to put capital aside, essentially a zero risk weighting. The result is that banks, particularly the weaker banks, will load up on the highest yielding Eurozone sovereign debt. Parentheses the most risky. And if and when a debt restructuring is necessary to do anything meaningful with the debt stock is to decapitate your own banking sector. They call this the doom loop. And it really is a doom loop. Italy is perhaps. Yeah, is perhaps the best example.
- [41:31]
A
So let's do that. Let's move on to the future of sovereign debt and the absolutely terrifying existential threat, which that is Italy, which has everything. You're talking about this massive debt stock, weak domestic banks loaded up with sovereign bond. What could possibly go right?
- [41:57]
D
Well, First thing to realize is Italy carries a debt to GDP ratio of about 132%. Now, most economists will tell you 60% is the high side of healthy. 90% is red zone, 130% too. Only Greece in the Eurozone has a debt to GDP higher than that. How has Italy managed this? They managed it the same way Japan has. They have in their domestic financial institutions a kind of captive audience for their bonds. Italian banks have been rolling over their exposure to the Italian government through endless political and economic crises since Hadrian died. And that is both good news and bad news from the sovereign standpoint. Good news is that that has a much more stable debt stock without the skittish foreigners. In your debt universe, you don't have to worry as much about your yield spiking because Felix Salmon wrote something on Axios that was unflattering about your country. The bad news is that if you do have to restructure the debt, the techniques you can use are going to be severely constrained by the fact that so much of it is held by your own financial institutions. And that will be Italy's position if as and when the crisis intensifies. In a sense, Italy is too big to save. I don't think there are even in the esm, the body that was set up supposedly to help deal with future crises. The Italian debt stock is north of 2.3 trillion euros. It is the fourth largest sovereign debtor in the world. The idea that the esm, or the European Central bank, which has promised to buy bonds of an afflicted country in unlimited quantities. I guess Mr. Draghi, because he controls the printing presses, has the financial firepower to do that. I don't think he has the political firepower. I think his largest shareholder, Germany, would find that prospect pretty terrifying.
- [44:39]
C
I think it's Maybe potentially even worse than Lee suggested. Because what we're seeing literally over the last couple of weeks with Italy, but we had seen this in the tea leaves before, is that every time some of the foreign investors leave. I think the FT reported that more foreign investors were leaving the last couple of days. Every time they leave, what I suspect is happening is that the government and the bank of Italy are calling up their favorite bankers, local bankers, and saying, you know, you need to buy a little more. So it's not just that they're rolling over, that the locals are substituting more and more for every skittish foreign investor. And this is something that in the Eurogroup meetings, whenever other countries say, you know, things are coming, getting more and more dangerous, it is the one thing that the Italians fight tooth and nail to preserve, which is the ability to twist the arms of their local bankers. And to me that. That's terrifying.
- [45:53]
B
Yeah. I mean, are there any, just in, is there, are there any positive ways out? Like what, what do you think will be the potential outcomes that we can consider?
- [46:03]
D
There is an obvious path out of it, and that is the debt continues to be rolled over, but the government embarks on a self designed fiscal adjustment program. Remember, Italy also suffers from the fact that it hasn't had any economic growth for a long time. And if they can restart the growth, constrain their temptation to just finance deficits by increasing the debt stock over time, you could bring down the debt to GDP level.
- [46:47]
A
So this sounds like the Mexican flying the sky.
- [46:50]
B
Well.
- [46:53]
D
Yes, Mr. Minister.
- [46:56]
A
Also more to the point, not only is this exactly the same as the Mexican pie in the sky solution, but this is also you're moving in the wrong, Italy is moving in the wrong direction politically. If you look at the government that they just elected, was a clear popular mandate to do whatever the opposite of that was. That you can't force a country, as we learned in Greece, to implement a bunch of neoliberal policies when the population is vocally opposed to that. At some level you have to deal with the fact that these countries are actually democracies. Or do you not?
- [47:39]
D
You do. No, you certainly do. Which I think explains why MeToo is observing this relentless increase in the yields on Italian government paper. People are no longer, some people are no longer convinced that you can continue this situation forever.
- [48:03]
B
I mean, isn't this also kind of the danger right now we see throughout Europe, which is that you have these competing populisms where you have kind of a lot of the southern European countries who are dealing with a tremendous amount of debt in their populations, unsurprisingly, don't want a lot of the austerity measures that seem to be required. But then you also have the countries like Germany that have a completely different populist movement in a more probably slightly on the right popular, very on the right in terms of Germany, but who are pushing back against any form of debt relief whatsoever. And is this is just a tension that exists within, within Europe that is, is there any possibility of getting out, out of that?
- [48:40]
D
Well, I think you've accurately stated it. It is very much by the way a north south divide. It seems to me one of two things is going to happen. Either this will induce a further fiscal union in Europe. Right now they have a monetary union in the form of the Eurozone, but not a fiscal union. And economists for a long time have said those two things are hard to coexist.
- [49:16]
A
And maybe Brexit helps on that. Right, without the Brits being abstractionist, it makes it marginally more possible for a fiscal union.
- [49:23]
D
I'm not sure the Brits were the most obstructionist in this regard.
- [49:28]
A
No, it was the Germans.
- [49:30]
D
Well, it's not a question of obstruction. It is as Anna said, perfectly plausible for German politicians to say wait a minute, why are we being asked to send all of this money south? When you southerners by fiscal prudence could have had your economies in a much better situation than they are now. So either it results in further integration or perhaps disintegration. I hope the former myself. But what views in Europe differ on this?
- [50:11]
A
I think on that pessimistic note we're going to save the glory that is the court case between Ukraine and Russia for slate plus members only because that's a level of nerdery that frankly you need to be a Slate plus member to, to listen to. But we do, we do have time for a numbers round. Did anyone bring a number with them?
- [50:45]
D
My number is 3 million.
- [50:47]
A
Okay, what's that?
- [50:49]
D
3 million is the number of Venezuelans who have left the country in the face of this crisis. A million of them in Colombia. And this out of a total population of about 31, 32 million. So roughly 10%. This is in our hemisphere in this century, a refugee crisis that's approaching that of Syria and the situation that has afflicted Europe with such terrible consequences.
- [51:29]
B
And kind of connected with that mine is 1.4 million as in 1.4 million barrels a day, which was the most recent reported output of Pervesa's oil production, which is a significant decline from where they were, say, five years ago, when it was closer to 3 million barrels a day. And I say this partly because if you look at the. The just complete destruction of Petavas infrastructure throughout the country, I think that's really significant because I think people think, well, in a perfect world where you get a new regime, in where, you know, we. We get debt relief, there's this idea, even if oil prices go up, that production could just kind of magically increase. And you talk to a lot of people who are really involved and they say, no. Like, this is. This is a. This is just a mess. I mean, even when oil was significantly higher and you had Chavismo raiding Pay de Vista's maintenance budget for years. So this is just kind of going off of what we were saying earlier with Venezuela. Like, this doesn't look good for. Anytime soon.
- [52:29]
A
Me too.
- [52:30]
C
Mine is also 3, but not least 3. Mine is 3 billion, which is the amount that Mr. Putin lent to Viktor Yanukovych, the Ukrainian leader, immediately before Yanukovych was deposed, and that Russia is demanding back. And Ukraine, in a bit of good news in the UK courts, has actually been able to fight it, saying, you took our stuff. We're not gonna pay you, and I love this case.
- [53:00]
A
Okay, we're gonna talk more about that in slate plus. But my number just to finish this round is 74, which is the price of the glorious Argentine Century Bond. Because having restructured this, Argentina came back to the market with a century bond, which means it doesn't mature for another hundred years. And they got very close to 100 cents on the dollar when they sold this bond. That price didn't last very long. It is now imploded. Somewhat nice, I might suggest. And of course, this. This podcast is where you go for investment advice. This is not necessarily a bargain, even at 74.
- [53:48]
D
Felix, may we now safely infer what is in your 401k?
- [53:55]
A
I've been watching it. You see, Lee, I. I forgot to phone you before. Before Investing my entire 401k in Argentine century Bonds, but.
- [54:05]
B
Convexity.
- [54:07]
A
Yeah, I know. I had this broken convexity.
- [54:10]
C
You're going to move it to Kazakhstan bond.
- [54:13]
A
That was my number last week. 1.5% coupon in Kazakhstan debt. Yeah. For some reason, the sovereigns of the world, for all of these names that we have rattled off, and I was like, in the back of my head, I was like, we haven't talked about Uruguay. There's so many other places that have gone through this. Or we actually haven't mentioned the single African country. And they've all redstructured that at some point. For all of the fact that sovereigns default all the time. Yeah, they can still seem to borrow with great ease and it's a weird paradox. We'll talk more about Ukraine in State plus, but otherwise that that is it for us this week. Thank you. Thank you for listening to Slate Money and keep the emails coming to us. The address is slatemoneylate.com Many thanks to Max Jacobs for producing and mostly many thanks to Misu Gulati and Legal Kite for coming in today and doing this amazing show. And we will talk to you next week on Slate Money.