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12/14/08

Ecuador Bonds: Law, Justice and Money


President Rafael Correa of Ecuador has made a very, very big mistake.

The main problem on writing a blogpost about this subject has been where to start. The roots of Correa's decision on Friday go back to at least 2002 (according to all the literature I've read, anyhow...it might go back even further) with a series of papers written by Alberto Acosta when the phrase 'illegitimate debt' was first coined. Then there's the complexity of the issue, too. There are a lot of things that bonds market watchers instantly understand about the decision for a country with the means to pay to default on its obligations, but via IKN I try to stay away from long-winded technical stuff as much as possible. FWIW, check out Felix Salmon's post on the default that was written maybe three hours after the news hit, as on purely financial-head terms I agree with nearly every word written. Or as my own example I could get all wonky on you and explain why the 2012 will be the main battleground (for example that bond needs just 25% of holders to band together to start the legal proceedings rolling...others need 50%). But the nub of the issue lies in three basic themes, namely justice, law and money.

Justice: Correa believes he has justice on his side with his lapse into default on the Global bonds.

Law: The bondholders have the law on their side on same said issue. Little doubt on that score.

Money: Correa's call to default and then demand an a posteriori severe haircut on the bonds value is a big tactical mistake.

Inconsequential as they may be, I have my own views on these. Firstly, on the question of justice I think Correa has a good point. A very good point, in fact. The way that the bonds were first structured and then restructured leaves Ecuador bound head and foot. There are some very unfair clauses in the deals that restructured the previous defaulted bonds, including not allowing Ecuador to make prepayment or significant open market purchases at any discounted prices. These mean that Ecuador has to pay the interest, and pay, and pay and pay...not other way out. There are many other examples of the way the creditors screwed Ecuador back in 2001 and I suggest you check out the debt commission's finding for more information.

Is it injust that a small country such as Ecuador pays through the nose for its debt burden, and is hamstrung in such a way that it can't get out of paying? I say yes. I say it's a classic move by the big boy to keep the little upstart in a submissive position over a long period of time.However.......

The question of law is another thing altogether. The bonds were signed into a legally binding contract by both sides. They are covered by New York courtrooms. When the cases come up in front of the judge (and you can bet your house that they will) it's going to be a really straightforward call. Ecuador will be told to pay. Period. No doubts, no fuss, no waffle. From there it all depends on how Ecuador reacts to the order to pay. If it says "nope, won't pay screw you gringo", things such as embargoes, forced liquidations and such come into play. There are a thousand different ways for these things to play out, but as an example off the top of my head the New York courtroom could order a third party such as Peru to hand the money over it was about to pay to Ecuador for oil delivered. Suddenly the payment money is squeezed out of Ecuador's current account. Ugh.

Now for the issue of money. Let's put this in the most basic way possible.

1) You own bonds.
2) Ecuador defaults and then offers to pay you 20% of the bonds' face value.
3) Fairly straightforward legal action is available that will almost certainly go in your favour and you get to recover 100% of the bonds' face value.
4) Go on...take a wild guess..........

Correa's decision to default and then afterwards offer to pay a small percentage of the bonds' face value is naive. It's bad poker. If he'd decided to take the whole shebang to court as recommended but for the time being paying the due coupons and keeping the country out of default, this line would have some credence. Frankly this is what I thought he'd do; I mean, we're talking $30.6m here. That was my mistake. That's the kind of money you lay down to try and win a $3.9Bn jackpot, no? But he's just being silly here, sad to say. This is not realpolitik. He said that he prayed to God before making his final decision, and who am I to doubt. But I also think he read that John Perkins book once too often.

It may not be pretty and it may not be "fair", but it's Kapitalism, baby. It sucks on many levels but Ecuador is now running headlong toward serious economic and therefore social problems. I wish Correa the best of luck with what he's trying to do. Depending on one's point of view, justice is his main weapon (personally I think justice is on his side, here). But be clear; he's trying to do something that has been tried many times before and has never worked. Not once. He's also trying something that will likely lead to the end of his Presidency. That's a real pity, cos I think he's good for Ecuador and a damned site better than the establishment leaders who are now rubbing their hands with glee and counting down the days before they get their corrupt hands back on the reins of power.