I had no idea that Ecuador had defaulted on its debt.
Felix Salmon’s Reuters piece is fascinating, not least for the tone of astonishment that “the country has won and the private sector has lost.” Aren’t small open countries like Ecuador helpless in the face of the mighty capital markets? Not at the moment:
[President Rafael] Correa didn’t pull the trigger until he could see the whites of his opponents eyes: he announced that he was defaulting on the 2012 global bonds at exactly the time that three huge hedge funds, which held Ecuador’s debt, were being forced by their prime brokers to liquidate their holdings. As a result, the selling pressure on Ecuadorean bonds sent them tumbling from the 70s to the 20s almost overnight.
They would have fallen further, into the waiting arms of a small army of hungry vulture funds… But then Ecuador pulled its next smart stunt: it used Banco del Pacifico, a large Ecuadorean bank, to start buying bonds at levels above 20 cents on the dollar. That was just high enough that the vultures didn’t want to amass a large position, and ensured that any future restructuring would face little organized opposition just because Ecuador’s bondholders were so fragmented. … And its final clever step was not to put forward a take-it-or-leave-it offer, as Argentina did, which would allow bondholders to agitate for a mass “no” vote. Instead, they just asked bondholders to name their price. Of course that’s what the bondholders did. None of them wanted to be left as holdouts.
The lack of solidarity among bondholders is noteworthy here (a group of disgruntled bond owners uses, telling if a bit comically, the slogan “United We Stand.”) Game theory might explain why most bondholders would take the country’s offer, but one suspects that in a different political conjuncture the game would work differently.
Also noteworthy is this: “Ecuador hasn’t been able to issue debt in years, so losing access was no big deal for Ecuador, as it would be for most other countries.” But why on earth should any country keep paying tribute to foreign bondholders if it won’t be seeing any more capital inflows?
Of course, Salmon might be wrong — which makes the case for default stronger, if anything. According to Marc Weisbrot, S&P raised the country’s bond rating following the default, and the price of non-defaulted government bonds rose sharply: “The debt reduction appears to have convinced foreign investors that Ecuador’s ability to repay its non-defaulted debt has increased.” It would be interesting to try to generalize this point. Even if you ascribe much more in the way of rational expectations to international lenders than I would, there is clearly some level of debt which is too high to be realistically serviced; in that case, repudiating some or all of the existing debt clearly improves repayment prospects for future debt.
On balance, despite all the huffing and puffing you hear in cases like this, it’s not clear that default has any repercussions on access to foreign loans. Jeffrey Sachs and Erika Jorgenson have an interesting paper that looks at the subsequent experience of Latin American countries that did, or did not, default on their debt in the 1930s. They find that “reputational effects on future access to credit … were low, so low as to be negative. … the costs of default in terms of future external financial flows were negligible. When the countries returned to international capital markets in the 1950s, no apparent systematic differences between the defaulters and nondefaulter emerges.”
Most likely the same will turn out to be true here: Post default, the income of a few wealthy bondholders will be a bit lower, the income of the citizens of Ecuador (or at least the government) will be a bit higher, and Ecuador’s capacity to borrow internationally will be unchanged.
Toward the end of his piece, Salmon quotes someone from Greylock Capital worrying that “as much as we can say this is an outlier, any country which runs into trouble has a great blueprint now of how to do it.” Let’s hope so!