Dec 12 2008 4:25pm EDT
Ecuador’s Idiotic Default
In the annals of idiotic political decisions, today’s default by Ecuador has to rank pretty high. The country failed to pay a $30.6 million interest payment on its 2012 global bonds, despite the fact that it has $5.65 billion in cash reserves and debt service accounts for less than 1% of Ecuador’s GDP.
As a result, Ecuador’s economy will suffer greatly. The country is a major exporter, not only of oil, but also of such things as shrimp, bananas, and cut flowers; trying to get trade finance for any of that will now be all but impossible.
But those aren’t even the biggest reasons this default is so stupid.
This debt has already been restructured twice, and there’s zero chance that bondholders will agree to it being restructured a third time. They know that Ecuador has the ability to pay, and they don’t like being bullied.
Most importantly, they have leverage. Yesterday, Judge Thomas Griesa, of the Southern District Court in Manhattan, ordered the attachment of Argentine pension fund assets held in New York, on behalf of defaulted Argentine bondholders. It’s the latest move in a long legal game being played out between Argentina and its creditors, and the creditors are scoring a few minor victories these days.
They face, however a formidable adversary: Argentina was careful to repatriate all its attachable assets before it defaulted, and the only reason the pension funds got attached is that they weren’t nationalized at the time. Argentina also has seriously heavyweight legal representation, in the form of Cleary Gottlieb — which used to represent Ecuador, too, until Ecuador fired them earlier this year and denounced them as criminals.
Ecuador’s bonds are all issued under New York law, and the country needs a good New York law firm to defend itself. Unfortunately, it’s having to make do with Foley Hoag in Boston instead.
Even with Cleary, Ecuador would have had a hard time defending itself against well-funded antagonists such as Elliott Associates and Greylock Capital, who are expert at navigating the legal system. With Foley Hoag, it has no chance, for one big reason: Ecuador has dollarized. The dollar is the legal currency of Ecuador; there is no other. As a result, all of Ecuador’s assets, ultimately, are US assets.
Ecuador’s bondholders will vote to accelerate its debt very quickly. As a result, Ecuador won’t have to just pay its $30 million coupon payment any more: it will have to pay the full $510 million principal amount. And the chances are that the 2015s and 2030s will be accelerated too. What’s more, if it doesn’t pay up in full, its creditors will surely find a way to take the money anyway.
The only hope for Ecuador now — and it’s a slim one indeed — is that this whole thing has been engineered by people holding Ecuador’s credit default swaps, and that once they’ve been paid out, the government will quickly act to cure the default. (Incidentally, the single biggest writer of default protection on Ecuador is… Venezuela. You can be quite sure that the leftist solidarity between Rafael Correa and Hugo Chavez is no longer.)
If this default isn’t cured in a matter of days, Ecuador is going to lose billions of dollars it can ill afford to see go. Surely Correa knows this — and surely he knows, too, that whenever Latin American presidents announce a debt default, they rarely last long in office. Which makes this decision even more inexplicable. But there’s Ecuador for you: always bet against the country taking the logical and sensible course of action, and you’re likely to make a lot of money.