The pleasures of default

Fri Jan 7 02:02:16 PST 2000

>I'm kind of intoxicated by this idea of yours that
>defaulting on loans can cut the Gordian knot of unequal development. I
>believe Enrique and Patrick Bond put forth similar ideas last century, but
>I never thought I'd hear the like from an ex-central banker. If you are
>still avoiding those German accounts, I wonder if you could expand on the
>likely fallout and why it's nothing to worrry about.

OK, it's Friday morning, I'm General Guel and I've decided to pull the red handle. Here's what I do. Any resemblance between the below and a document called "Mexico -- illustrative sequence of steps" lurking in the files of the BoE would be illegal, and is thus a figment of your imagination.

1. I retain the services of two banks -- Banque National de Paris and one of the Wall Street ones -- probably Goldmans, because they love to get involved in this sort of high-profile deal. The idea here is that I need a friend on Wall Street for some of the later steps, plus there needs to be someone on the steering committee who understands Cote d'Ivoire a bit, and BNP is one of the biggest foreign banks there. Plus BNP now has Paribas, which is a good bond house in itself.

This will be a bit pricey (or at least Goldmans will -- BNP may do it for free), but will be worth it later.

I tell my bank advisors that their services will be needed for a review of the financing of Cote d'Ivoire. This may involve a large international bond issue. I set them to work gathering information on my economy. They're unlikely to provide useful advice, but it will keep them busy until needed.

2. I get on the phone to the Africa desk at the IMF and tell them that the political situation in Cote d'Ivoire makes it impossible for me to agree to their program and maintain any hope of stable government. I demand to speak to the Managing Director or one of his deputies. I arrange a meeting in London (I don't want him to be in the same time zone as his staff when I tell him my news, because I want him to panic a bit).

I tell the managing director that Cote d'Ivoire's reserves are being depleted quickly, and that there is a danger of a run on the domestic banking system. I tell him that, unless the situation changes, I will need to declare a temporary moratorium on foreign payments by next Thursday. (I'm giving them four days to get an IMF team out to Cote d'Ivoire).

When the IMF team arrive, I greet them with my advisors. Seeing the presence of a load of private sector bankers will at once reassure and intimidate them. We start discussing details of the package.

3. It's now next Thursday. I take a look at the price of my bonds, which will have started to tank. Because of this,. I know that there are rumours circulating in the markets; someone will have leaked. I call my advisors to a breakfast meeting at 0600 (make 'em work for their money). I tell them that at 1200GMT, I plan to announce a moratorium. I wave aside their objections, tell them that the decision is made and ask them to start drawing up names for a creditors' committee.

I spend the morning preparing myself psychologically by going through the following arguments in my head:

a) Companies go bankrupt all the time; reorganising in Chapter 11 is standard practice in the US b) A default is a funeral, not a disease. The problems of my economy will be there whether I default or not. c) What I plan to do is to make the creditors provide something which looks less like debt financing and more like equity. In the future, Cote d'Ivoire will have to pay more for its debt -- fair enough, in the future I may choose to default again. I'm giving the creditors a higher return in exchange for sharing some of my risks. This is not a bad thing.

At around noon GMT (around opening time in New York), I make the announcement at a press conference, making sure that the guy from Goldmans is sitting next to me and making a big deal out of the fact that I've hired them and BNP. I make the following points:

a) That I hope to maintain payments to the IMF, but that this will depend on the availability of bridging finance, which in turn will depend on the successful conclusion of a program b) That capital controls will of necessity be introduced, but that I hope to lift them at the earliest opportunity c) That trade finance is not affected by this moratorium.

I then sit back and watch my bonds on Bloomberg. They tank horribly in London (main centre for trading Cote d'Ivoire debt). At about 1500GMT, I get together with the IMF team, and we release a press statement stating that the team is in the country, and that I am co-operating fully with them to work out the problems. This is as close as you will ever get to an "IMF-sanctioned default", and is basically taken as such by the markets.

That press release will probably halt the free-fall in London, and my bonds will recover a bit on the New York market, after the close in London.

In the evening, I discuss with my advisors the names for the creditors committee. We work into the night, calling up the creditor banks and asking them to send their representatives out to Abidjan. If any of them get nasty with us, we use our scare tactic -- I get Goldmans and BNP to whisper to them that the rise in New York is rumoured to be the result of buying by vulture funds. Before going to bed, I read the early edition of the next day's FT -- it has an editorial which bemoans the default, but notes that it has been "very well handled by Goldman Sachs".

********************* TIME PASSES *********************

It's now about March, and the creditors' committee negotiations are taking up most of my time.

Obviously, the IMF more or less crumbled, and is the major contributor to a loan facility that allows me to maintain payments to them (the French and German governments lent a bit more; the US gave a bit). The IMF would never allow me to default to them, because it would burst the bubble of their status as a preferred creditor.

The program only took two months to negotiate. I didn't fight too hard on the conditionality because I know it will be renegotiated at a later date. The fact of the default itself will give me an excuse for missing all the targets.

I've paid the army and lowered domestic interest rates (caveat -- insofar as the IMF will let me). Things are pretty bad, but I keep telling myself that it's a consequence of the cocoa price, not my default.

The creditors should be willing to settle at around 50-60 cents in the dollar. The few vulture funds involved have been bought out by larger creditors. I have now achieved a foreign transfer payment equal to up to half my gross external debt!

But now I want to lift capital controls and start running a big external deficit to help support my reflationary policies (screw the IMF program, I'll renegotiate it). For that, I now need foreign funds.

I call up BNP and Goldmans, and tell them that Societe Generale has advised me that market conditions are right for me to float a bond issue of (this is a guess; I don't know the exact magnitudes) around US$250mn. BNP and Goldmans go crazy, calling SocGen every name under the sun. It would drive them mad (specifically, it would cost my advisors their bonuses) to lose this deal to a competitor. BNP and Goldmans eventually get the mandate for my bond issue (oh yeh, by now I want $300mn).

The creditors will take this issue up! Why shouldn't they? After all, my economy is now in a much better state than it was three months ago, when they were prepared to hold my bonds. And I'm offering a fantastic yield on the bonds (making sure that I have an option to refinance later when things have blown over). Just the ticket for an underperforming fund manager who needs a boost to returns. The creditors may have some dim idea that they're reinforcing me in my behaviour, but to actually do anything about it would require them to think into the long term, when I'm dangling a carrot in front of their faces now. And that's something they're consitutionally disinclined to do.

The other thing I do to get the yield down is to attach warrants to the bonds, dependent on the cocoa price -- ie I pay more if the price recovers. Again, the name of the game is shifting some of my risk (Cote d'Ivoire's) to the investors.

The FT publishes another editorial, noting that I have "returned to the markets" and saying how gratifying it is that I have such "market savvy" (horrible phrase). They note that default was not an "easy option" and that "other emerging market debtors should take note of the austere IMF conditionality". It never prints a word when I renegotiate the package.


Lather, rinse, repeat as necessary. While we were at the Bank (I prefer to think of myself as a "failed central banker" rather than "ex-", it has a delightfully seedy ring to it, like "failed seminarian"), a lot of ink was spilt over the issue of "Can Sovereigns Issue Equity?" because if you analogise developing countries to small businesses, it seems that they should be financed through equity, not debt. It took me years to realise that debt on which you plan to default is pretty much as good as equity.

And now our Netherlands guy has put through his contribution to Flemings Banks News, so it's time to do some work.



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