Michael Livermore 0:11
Hi, this is Mike Livermore, and with me today is Mitu Gulati and Lee Buchheit, both world class experts on sovereign debt. Lee spent several decades at the law firm Cleary Gottlieb, where he was a major figure in the legal wrangling in the wake of many different foreign debt crises. The Guardian, The Guardian, newspaper, once referred to Lee as, quote, a fairy godmother to finance ministers in distress. Mitu is a colleague here at UVA law, we’re very lucky to have him, he writes on a wide range of topics, including sovereign debt restructuring, he also co-hosts the podcast clauses and controversies, which is a lot of fun. And listeners should definitely check that out, if they’re interested in the conversation that we have today. But just to get us started, I thought we might kind of begin with how you got your start how you guys both got your start in sovereign debt practice. So. So Lee, what what drew you to that area, as you know, as something that you wanted to devote your career to?
Lee Buchheit 1:15
Well, thanks, Mike, I appreciate the invitation to be on with you, you folks. It was so much else in life pure serendipity. I had been posted to my firm’s London office in the late 70s and early 80s. And this was the end of the syndicated loan boom. So the great boom that followed the oil shocks in the mid 1970s. And I got back to Washington, just about Washington was my home office just a couple of months before Mexico declared a moratorium on payment of its external debt. And I got a phone call from a colleague in New York and he said, suddenly, you’ve been doing these syndicated loans, you must know how to restructure them. And I said, Oh, sure, sure. Little did we know that the circumstances afflicting Mexico, afflicted 24-27 other countries, and all of them would be driven into a full scale debt restructuring within the matter of a couple of years. But working then on Mexico, which was very much the flagship restructure in the 1980s. Many of the countries that followed Mexico called my firm, and we had the privilege of helping them. But I realized, almost from the moment it started that this was for me, because the legal elements in that time was very, very small. No one had done this since the 1930s. And so the legal component was probably 25%. Politics, both domestic and international were 50%. And the remaining 25 was pure theater. And my my weak spot has always been the law. So I figured this, this was perfect for me. And I just decided to make it my life’s work. And I’ve done it for 40 years.
Michael Livermore 3:47
Yeah, that’s, that’s, that’s fascinating. It is interesting how those early serendipitous experiences end up just shaping our life paths. Yeah. How about you, Mitu? How did you get interested in in this general area of laws as a as a kind of object of scholarly inquiry?
Mitu Gulati 4:04
Oh, I think I think by mistake when I was a junior associate, like I think you were a long time ago at this firm Cleary Gottlieb, where Lee was one of the superstars and I didn’t know anything about sovereign debt. Turns out this is actually stuff that my father used to work on, but I didn’t even know what he did. But I wanted to do foreign travel. The whole point of going to one of these fancy Wall Street firms I thought was I want to travel business class someday. And I had heard Lee Buchheit like he’s the ticket to go business class to exotic locations. So I tried there was a long line. I mean, he was the star so everybody wanted to work with him but the barrier to entry. Other people did not realize as quickly maybe because, you know, I have a devious mind was flowers and chocolates to his assistant, then you could jump the queue and then Lee got stuck. I think she told him there’s only one person who wants to work with you. That wasn’t me.
Michael Livermore 5:18
Very smart. Very. So how long did you guys work together at the firm?
Mitu Gulati 5:21
Oh, not that long. I think our research collaboration, we became friends. And Lee quickly realized that you know that I was sort of an incompetent lawyer. And he’s the one who sent me away. If I remember correctly, a judge called Lee and said, I need a law clerk, one of my law clerks is has gotten pregnant, or is there was some something that got it started and Lee told me, he said, You’re not very good at this job. Try something else I never said. I think it was he encouraged me to try other avenues.
Michael Livermore 6:04
thinking about this academic thing. Maybe that’ll work out? Yes,
Mitu Gulati 6:07
yes. But then, some a couple years later, he, he had this client, Ecuador, and had an idea for a transaction that we had talked about, but it seemed legally dubious at the start. So he said, maybe this is something that you and your students can think about. And we started thinking about it. And as as, as we thought about it in class, we ended up thinking this could actually work. And so Lee and I wrote an article about that transaction. He, he implemented it. And we’ve written at least one article every year since then, and that was probably 25 years ago.
Michael Livermore 7:02
Yeah, that’s it’s really wonderful. Maybe just for for an audience. It’s unfamiliar with the with the world of sovereign debt, we could just start with, you know, some basics to kind of situate ourselves. So. So one question that that I think, kind of naturally arises, you know, you know, we’re in the US. And, you know, we know that the US government borrows a lot of money, and that there’s a substantial amount of debt. But just as a as a basic question, why? Why does the US Treasury borrow money? Why, you know, there’s other ways of getting money, we can tax we can, you know, the US government’s actually in a position to, to print money. So what’s the what’s the advantage of, of debt versus these other ways of, you know, putting, you know, little green pieces of paper into the into the federal treasury?
Lee Buchheit 7:52
Well, the answer is politics. Part of it is politics. The only honorable way as a politician sees it that you can get money is borrowing it, the alternatives are politically unpalatable. They are taxing, which no one seems to want to do or cut expenditures, which no one seems to want to do. So if you’re a government, and you spend more than you take in, that’s called a budget deficit. The only way to cover the budget deficit is to tax more, spend less, both of those are politically unpalatable. Or you can borrow, and borrowing has borrowing is, in one sense, an intergenerational sin. Some poor devil some time in the future, is going to have to restrict their standard of living in order to service that obligation. But from a politician standpoint, the principal virtue of that poor devil is he or she hasn’t been born yet. It doesn’t. They certainly can’t vote. Now, you ask the other question, which is why not just print this stuff? After all, we do have the printing press. And there is a theory very popular in certain quarters now called Modern monetary theory, which is just that let’s just print all we need, right the answer The answer to that is that fiat currencies that is currencies like the US dollar that are backed by nothing other than an assumption on the part of everyone who holds them, that they will be able to use them to buy a pound of butter or to pay your taxes or whatever it is, the value that the currency will have is to some degree linked to its scarcity. And if you simply printed endless amounts of money, you’d find yourself looking more like Weimar than then you want to. And so it is it is principally inflation. That is the worry with simply opening up the printing presses plus the fact. No one believes that if the US Congress thought that it could spend all the money wanted, just by hitting a button on a printing press my heavens, Bernie Sanders would think that he had died and gone to nirvana
Michael Livermore 11:04
It’s a constraint on on on spending basic And I assume that the position in the United States is different from from other countries? I mean, you know, I think the the new monetary folks and, and others would argue that the US is in a special position, I could, we could argue one could presumably argue with that. But presumably, printing just printing money isn’t kind of even in the cards for a place like Mexico or, you know, Bolivia or other jurisdictions and what are the so what are the special factors that would make that, you know, that option especially, and the taxation option, obviously can be very difficult when you have a substantially reduced tax base? So what are the what are the factors that affect these these kinds of decisions for developing countries, especially?
Lee Buchheit 11:58
the United States, along with a couple of other countries like Japan has the inestimable benefit of borrowing being able to borrow in its own currency? So at one level, putting inflation aside, at one level, no creditor of the United States of America need worry that the US will not have the money to pay hem back.
Michael Livermore 12:29
Right? Dollar just to reiterate, because it’s it’s $1 denominated thing So the US government can get his hands on dollars as much as as much as it wants.
Lee Buchheit 12:37
Exactly. No Mexican finance minister can say that. And therefore, when you lend to Mexico, you’re taking a risk that when the time comes to repay, the country will not be able to raise either by exporting goods and earning dollars or borrowing dollars, the money to repay, we also have the enormous benefit of being the world’s only reserve currency. And what that means is, you’ve got almost a captive audience of central banks and others out there who need to buy your obligations. So that we enjoy huge advantages. And Mike, we take full advantage.
Michael Livermore 13:33
I think people don’t don’t realize, you know, many folks in the US don’t realize how advantageous the United States government is in these, you know, in these markets, and then we all are beneficiaries of that situation. It’s really incredible. So, so who owns this, you know, so I can buy treasury bills? And, you know, presumably, that’s how some some foreign debt is held. But I doubt that’s the lion’s share. So who’s kind of on the other side of the transaction? We know that there are the the there are the borrowers the states and who’s on who’s on the other side who’s buying this debt?
Lee Buchheit 14:11
Well, today, the principal buyer is the Federal Reserve and the US Social Security Administration. What has happened since the financial crisis of 2008 is that in order to stimulate the economy, the world’s large central banks like the Fed, the European Central Bank and the Bank of England, have been pursuing a policy called quantitative easing. What it what it means in practical terms is that they buy the debt of their own government And that creates demand that reduces the interest rate that the government would have to pay on that debt. And that reduction in the interest rate ripples through to all borrowers, public and private and encourages people to borrow money, build new factories, and so forth. So right now, an enormous buyer of US debt is the United States, you might think that is incestuous. But it’s the reality. other central banks buy a lot of it, the Chinese hold more than a trillion dollars of it. And then you’ve got investors, sovereign wealth, funds, etc, that need to invest their money in something that they regard as safe a safe store of value. So
Michael Livermore 16:01
and that now, this is us, this is US debt, which is considered safe, for various reasons. And what about the kinds of debt that you’ve often found yourself working on, you know, in, in places like Mexico, who’s who are the typical parties that own that that kind of debt of, you know, countries that are not kind of as well fiscally positioned as the United States?
Lee Buchheit 16:24
Well, for an emerging market country, there are likely to be three categories of creditors. They’ll be the multilateral institutions, the Bretton Woods institutions that were set up at the end of the Second World War, the IMF, International Monetary Fund, the World Bank, the Regional Development bank’s Asian development, bank, African development, bank, etc. Then you have what we call bilateral creditors, these are government to government loans. And then commercial creditors, they can be a wide variety, they can range from commercial banks, to institutional investors, the Aetna Insurance Company, the fidelity mutual funds, sovereign wealth funds, the Singapore sovereign wealth fund, to so called hedge funds, private invest investment vehicles, that by sovereign debt, and within that category, you have a sub group that specialize in what they euphemistically call distressed, sovereign assets.
Michael Livermore 17:39
So you’ve worked in a lot of instances where sovereigns have gotten themselves into trouble one way or the other, where essentially they’re there. They can’t pay their their debt back. So so how does this happen? I mean, is it just, you know, like, like, I know, If I ever find myself where I can’t pay my debt back, I mean, that might be because I made bad decisions, it could be because of an external shock that was unexpected. What are the kinds of situations that result in sovereigns kind of unable to make their you know, meet their commitments?
Lee Buchheit 18:13
I would say there are three types, the most, forgiving, are circumstances where the country is hit by an external shock. So the the hurricane tidal wave in Indonesia, the earthquake, or a pandemic, that causes severe disruption to the world’s economy and makes it impossible for the country to export its commodities. There’s no culpability with those things. And so they’re frankly easier to deal with. In most cases, the cause of the country’s problems will be chronic fiscal mismanagement. A country that, for the reasons we just described, the local politicians find it easier to borrow than to trim the public sector payroll or limit pensions or tax. And so the debt relentlessly accumulates, and at some point, you’ll see these countries are completely dependent upon the willingness of new investors to lend them the hard currency needed to repay what they already owe. And if those investors get skittish, they will, in the first instance increase the interest rate they want to charge for those loans. But in the final instance, will cease lending altogether. This is Greece, in spring of 2010 300 billion euros all in the form of bonds. And no one wanted to buy Greek debt anymore. So what do you do? But then a final cause is sometimes just a buildup of debt stocks at a time when it is easy to do it. This flicks, commodity exporters in particular, so oil goes to $100 a barrel. And you’re an oil exporter. Well, a lot of people will lend you money. And it isn’t too hard for a finance minister to persuade himself or herself that if everyone wants to lend me money, I’ll I’ll take it and then oil goes back to $40. And then you’ve got an unsustainably large debt stock,
Michael Livermore 21:21
right? Got it. So these are si si have these different causes. And they’re, you know, presumably they can be they can be mixed up with each other, as well as that you could have some mismanagement and then an external shock or some, you know, unpredictability in commodity prices and things come to a head. And it becomes clear that, you know, that the the country is in trouble. And presumably, they they they call Lee Buccheit or someone in a similar position, and they say, you know, what do we do, like, we’re literally don’t have enough money coming in, you know, we could if we try to raise taxes, you know, more, we’re worried that it’s going to, you know, depress the economy and tamp down on on growth, whatever are what are our options? And so what is what are some of the answers that are, you know, just in kind of broad strokes, what, what are some of the answers to that question?
Lee Buchheit 22:18
Well, History says that countries facing those situations tend to delay announcing the need for a debt restructuring as long as they can. History says that politicians demonstrate a pathological procrastination. Why? Because debt restructurings are disagreeable. Always. And if you can put it off to the next administration, that that looks awfully good. If you can’t, normally, not invariably, but normally, the country would go to the International Monetary Fund, and say, We need assistance in the form of a stabilization program, the fund will send a team of economists down and the first thing that team of economists will do is say, Well, you’ve got these weaknesses in your economic policies, and we want you to fix them as a condition to the program. And that can often be politically uncomfortable. Because the weaknesses are the very things that the politicians did not want to do on their own, like raise taxes or collect taxes. And then the country and the IMF will usually say if your debt is unsustainable, not usually it will always say, if your debt is unsustainable as they reckon it, sustainability, they will tell you that you need to do some form of debt restructuring. So you need to go to some or all of your creditors and ask for some form of debt relief. And that then launches you into a discussion with your bilateral creditors, your government creditors and your commercial creditors.
Michael Livermore 24:39
And then and and so so these conversations get started in presumably what the you know, what the issue are here the country says look, we can’t pay back our debt on the current terms. You know, what, what can you what can you do for us and and it just, you know, presumably everyone’s in a position where you If it’s broadly recognized that this is the case that restriction is going to be necessary, the lenders want to get as much out of the out of their existing debt as they can, in the end, the borrowers want to pay as little as possible. So so how do they possibly come to an agreement in these circumstances?
Lee Buchheit 25:18
Usually, with great difficulty in the eye, the IMF will conduct something called a debt sustainability analysis. That’s a forward looking projection of which really says, based on certain assumptions about the economy of the country. How much can the country reasonably afford to pay in external debt service? And by reasonably I mean, the every country, I guess it’s theoretically capable of servicing its external debts if it took extraordinary measures. I remember one creditor telling me, we simply don’t understand why you don’t sell Patagonia to the Chileans. I remember another one saying, you know, you could get a wonderful price for the Acropolis. These are these are measures that are obviously politically impossible off the table. Yeah, yeah. And then, yes, you can ratchet down austerity on the economy, but it is, in the first instance, an enormous political problem. And it is, in the final instance, a moral problem. Do you let your citizens go without food, education, and, and, and medicine, in order to pay hedge funds in Greenwich, Connecticut, that’s how it’s that’s how it’s viewed. So the IMF makes that basic judgment, how much you can afford to pay, and then typically, the country will cling to that, and say, to its creditors, look, this is the quantum of debt relief we need. And the discussion then becomes who provides it, the commercial creditors will want the bilateral creditors to do it, the bilateral creditors will want the commercial creditors, the bondholders will want the bank loans, the banks will want the bondholders, et cetera, et cetera. And so that is the negotiation process and that the country is launched on.
Michael Livermore 27:41
And it’s it’s really interesting in that in the kind of examples that you’re giving, of how, obviously and deeply normative, the question of kind of how much can a country, you know, can a country pay is, you know, and that I think that can get lost? In some of these debates. It’s not just a kind of a technical question about what you know, what the capacity is, there’s, there’s just these kind of, you know, moral limits. And, of course, you know, obviously, if you do too much austerity, and you stop feeding your population is not gonna be good for long term economic growth. So there’s, you know, there’s some of those issues in there. But, you know, just kind of as we’re thinking about the normative implications of, of these, you know, broadly kind of sovereign debt issues, you know, you’ve worked with a lot of countries in these situations. And I recall it at various points, you know, over the last several decades, you know, general kind of broader public conversations about debt, especially for the least developed countries and, and the role that debt has in in potentially impeding economic growth and development. Do you have views on that? Is the current structure of global debt a serious impediment to development? Are there things that we should be thinking about very broadly, to change the system? Or are we in equilibrium that is, you know, maybe not desirable on every dimension, but a kind of reasonable, you know, a reasonable accommodation of different interests?
Lee Buchheit 29:12
Well, I think the first thing Mike to realize is not all debt is bad, not all debt is good. Borrowing money to build the bridge, build the road, build a factory that encourages economic growth that is benign. The problem usually arises when the country is borrowing the money simply to cover chronic budget deficits. The politicians just don’t want to tax because tax and you don’t get reelected for a while The borrowing, cushions disagreeable consequences for the citizenry, they they’re not aware of it, usually, because no politician stands up and says friends, I’m not going to raise your taxes this year because JP Morgan is prepared to lend us the money. But for a while they’re the beneficiaries. But that quickly runs out at the time that the country can no longer borrow to refinance, repay what it’s already incurred, then come as the IMF, and the IMF will say you’ve got to raise taxes, cut the subsidies on cooking oil, reduce your public sector workforce cut public sector pensions. And all of a sudden, the average citizen on the street says, Oh, my gosh, this debt crisis is having direct and immediate consequences. And it by the way, this is a common thing. They don’t remember, because they never appreciated that the incurring of the debt, saved them from some of these disagreeable things, they will also say, a lot of the debt was simply squandered. You know, he went to corruption and went to build a statue of the dictator or whatever. So we never saw any benefit. But we’re the poor devils that have to pay for it now that the IMF is here. And we have to render our reform our economy to make us presentable once again in the market. So that we can return to this idea of borrowing money to repay what you already owe.
Michael Livermore 32:01
Yeah, so is it? It’s no, it’s no fun. No fun all around. Mitu, I was wondering if you had thoughts on this, just the I know, it’s a big question. But just the general relationship between, you know, high debt loads and development. Is it A, is it a red herring? Or is it a really serious issue?
Mitu Gulati 32:23
Oh, I think I think this is a giant Ponzi scheme that we are in right now, especially given the much higher levels of borrowing that we have seen across the globe during the COVID crisis, and I would have thought that we would have given some consideration to the fact that debt levels are increasing growth rates in many parts of the world are decreasing in some parts of the world where, you know, the economies are completely dependent on tourism, that they’re down to near zero, and that this will come crashing down. But we aren’t, we’re pretending that the easy money being generated by the Federal Reserve, the European Central Bank, and the low interest rates that the developed world has faced. That’s just gonna keep going on and on and on. I don’t know I think that Lee, who thinks he might have been able to retire is not going to be able to stop working anytime soon. Because I mean, the these countries are already crashing, and the debt restructurings, they’re not on the horizon. They’re coming tomorrow, day after tomorrow. So I just think this is, unfortunately we’ve had a little bit of respite, but disaster is right here. It’s not in the on the horizon. And
Lee Buchheit 34:12
Michael, yeah, nice. Let me let me give you the most poignant example of this in my career, I was called in to help a country some years ago, not by the government authorities, I was asked to come down by the United Nations Development Programme the UNDP. And you might say why. Answer: It turned out the country was spending 60% Six Zero % Of all the revenue the government collected in servicing its external debt. What that meant was that every other use of of government resources, health, education, military police were the government was not able to provide them and the UNDP, which had a very large office, there was frankly, picking up the slack. So the UN GP said, help them restructure their debt, so that more of the revenue can be deployed by the government in these normal governmental functions and take the burden off of us. So and and there are a lot of countries that are paying 4050, even as much as 60% of government revenues in debt service.
Michael Livermore 35:50
Yeah, that’s really staggering. Before I want, I do want to turn to, it’s a really interesting deal that the two of you are working on that has some very interesting possible environmental angles to it. But before that, I just, I just have to ask, in light of kind of what what Mitu was, was just saying is, you know, and then that sounds like if if if countries start to go into a kind of a cascading global crisis, where they can’t pay back their debt, and presumably that has ramifications for the financial sector more generally, is that the kind of thing that could initiate a very serious financial, you know, kind of a global financial crisis? Or is it the kind of thing that’s sufficiently kind of cordoned off? Or that the amount of money we’re talking about isn’t, you know, so massive that it might cause very real suffering and problems for the, you know, kind of affected countries, but it wouldn’t kind of broadly propagate through the whole financial system?
Mitu Gulati 36:53
This is this is the really, I mean, this is the really big question. There’s, there’s a conflict in the international financial community that maybe we will talk about it about whether or not we’re on the brink of just another Great Depression type. Or the that we have figured out how to solve it by just pumping money into the system.
Michael Livermore 37:19
And doesn’t seem like, forever.
Mitu Gulati 37:21
Yeah, two years ago, people were very worried. The IMF and the World Bank and the other international financial institutions put in place, a couple of mechanisms, neither one of which has worked, the only thing that has worked is the easy money that sort of inadvertently worked. So, you know, it’s, the solutions haven’t worked. And the easy money is now going to stop because I think the Fed and the ECB are worried about inflation. Sure.
Lee Buchheit 37:55
Yeah, what we fear is a contagious debt crisis, that is a circumstance in which multiple countries would be unable to refinance their maturing debt at more or less the same time. Classic example was the 1980s, when you had more than two dozen countries. We saw it a little bit in 1997, with the East Asian crisis, when you had Thailand and South Korea and Indonesia. But that’s, I think, what, what worries people for so long as the debt crises are in individual countries or a handful of countries, I think the system can absorb it. But if if the circumstance were to spread it, it would have a profound effect on the world economy, as the Latin American debt crisis of 1980s debt nearly brought down the banking systems in the developed world.
Michael Livermore 39:08
And so is this the kind of like on the order of magnitude of the the 2008? You know, truly massive financial crisis in Great Recession, recession, or is it worse than that? Is it is it maybe not maybe not that severe? We just we don’t know.
Lee Buchheit 39:24
We don’t know. But the difference is that this would have severe political ramifications, because you would have countries slipping in many cases back into poverty. And it can be geopolitically very disruptive.
Mitu Gulati 39:50
And we have to, I mean, we have to remember that many of the countries that are in trouble in the state They have huge debt loads, and potentially won’t be able to keep borrowing to repay the interest on those huge debt loads are still not out of the pandemic. And in the in the West, it’s so tempting for us to think that, especially in our little bubbles at universities to think that this is all over, we’re back to normal when much of the world is not out of it. They don’t have high quality vaccines. And now they go into a severe debt crisis. And the debt loads are just so much bigger than they’ve ever been before that I’m, you know, I am a pessimist maybe that you become a pessimist because you work on debt restructuring. So, back of your mind, you pray for more debt restructurings. But this is not what I’m praying for.
Michael Livermore 40:57
Yeah, so that’s troubling, kind of terrifying. And to maybe move us from one terrifying troubling crisis to another one you guys are working on. Kind of have this, you know, kind of came to my attention was a deal that kind of combines some of the issues that we’ve been talking around about debt, refinancing with climate change, and thinking broadly about how to kind of get the necessary resources that are needed really globally to mitigate adapt to climate change, and generally to address environmental problems around the world. So So you both worked together on a transaction to restructure debt in Belize, that had an interesting environmental component to it. So maybe we could just talk a little bit, you know, in terms of it might be something of a brightspot. thinking a little bit about how that how that restriction worked? And is it the kind of thing that could be expanded to other contexts? So what was the broad outline of how that restructuring worked?
Mitu Gulati 42:06
I should clarify that, that Lee and I wrote an article about sort of, it depends on what Lee says, may be the precursor to thinking about this, but Lee worked on the actual Belize deal and I did not and then I wrote about it. So all credit, and especially all blame goes to Lee. But I do think it’s it is very exciting in the sense of, if we do have a series of debt restructurings, maybe just maybe we can use that template to get some assistance for the environment as well. But Lee I’ll help you explain how you muck things up.
Lee Buchheit 42:53
Okay. Well, Belize, Belize, country and Central America facing the Caribbean. badly affected by the pandemic crisis. 40 to 50% of Belize’s GDP is directly or indirectly tied to tourism. And, of course, the tourists stopped coming. So it was a devastating blow. The country had only one bond in the international markets that had been placed back in 2007. It had always been troublesome the country is regularly hit by hurricanes and droughts and things that make it difficult for it to to service, its external debt. And we had restructured that bond three times in the last 13 years. Along came the Nature Conservancy, a non governmental organization and they said, Look, we have a program in which we, the Nature Conservancy will borrow money from the bond market. And on lended, to you, Belize, to allow Belize to make an offer to repurchase that troublesome bond at a deep discount. In return, Belize, which already had a pretty aggressive Environmental Conservation Program, agreed that it would accelerate that program and have it monitored by the Nature Conservancy that those sorts of funds allowed Belize to make an offer to its bondholders to repurchase the bonds there was a, a long negotiation, as you can imagine, in the end, the price was just above 50 cents on the dollar. But at the end the bid and asked for what the discount was five points or so. And Belize said we can’t afford to pay more than this, but we tell you what we’ll do, we will take a portion of the savings that this transaction produces for Belize. And we will pre fund something called an endowment account that is managed by the Nature Conservancy. And the annual earnings on that endowment account will be used in perpetuity to fund environmental conservation projects in Belize, particularly in the marine area, Belize has the second largest barrier reef in the world. And it is a place of enormous environmental diversity and, and sensitivity. And so protecting it is it is good for Belize, but it is good for the planet. And this was an effort to appeal to the public statements by institutional, many institutional bondholders that they are sensitive to what they call environmental social governance issues, and that they’re looking for opportunities to demonstrate their support for that, well, this was a tangible way in which they could do it. And so it was a technique used to bridge the final step in the negotiation. But it will result in a significant amount of money being used in perpetuity to for environmental conservation.
Mitu Gulati 47:20
So one thing that is, to me very cool about it, but also raises the question of whether it can be reproduced elsewhere is the amount. Lee didn’t explicitly say this, but it’s in much of the many of the press accounts such as Tommy Stubbington’s piece, in the Financial Times, where investors said to him, that they basically gave Belize another five cents on the dollar. Now to someone who doesn’t work in this area. This might not seem a lot, the Belize needs a lot of relief, What’s five cents on the dollar. But if you’re following the literature on ESG, and the greeniums, and it’s tiny, so that to the extent any greenium, meaning sort of the extra price benefit you get for being green, and environmentally kosher, is tiny, it’s like a few basis points. Five cents on the dollar is hundreds of times more than what normally we think people are willing to give for environmental protections. So either this was just a fluke, or Lee can do this magic, again. But there is this disjunction between the reality of what investors are willing to give. And the the reality of what they were willing to give in Belize.
Michael Livermore 49:01
Yeah, that’s really interesting. Let me just see if I just reiterate the structure here just to see if I actually understand what’s going on. So So Belize has creditors in the form of a bond. The Nature Conservancy goes into into markets and and borrows money that it will presumably have to repay Well, there’s maybe that’s just step one Nature Conservancy will have to repay the money that it borrows Is that Is that correct? Yeah. Yeah. Okay. So so Nature Conservancy borrows the money, Nature Conservancy lends the money to Belize, which then it goes out to the to the bondholders and says, Look, you know, we can’t pay back all of our debt. But we’re willing to buy back these bonds at a discount. And this is what Mitu was talking about, what kind of what’s the question of how much of a discount and there’s two factors that are going to affect how much of a discount one is just Belize’s financial situation? is kind of what we were talking about before. Like, how much can Belize actually afford to pay? And then there’s this question of maybe Belize can get a little bit extra in terms of its deal, because it is going to kind of have this arrangement with the Nature Conservancy. And the environmental effects here are twofold. That sounds like so one is in the terms of the debt agreement between the Nature Conservancy, or the original agreement between the Nature Conservancy and Belize, you know, where, you know, Belize, Nature Conservancy lends money to Belize, for the for this transaction, there’s some agreement to engage in environmental conservation. And then in addition, there’s this kind of the creation of this endowment that is being funded, kind of by the discount that Belize is getting on the debt repurchases that in brought out was that I did I did I repeat back to you what you said correctly, or? Yes, I missed something.
Lee Buchheit 50:49
Only minor tuning on the last bit of it. The quid pro quo for The Nature Conservancy lending this money to Belize was Belize accelerating its environmental protection program and in allowing the Nature Conservancy to monitor it and all the rest of it. So those were promises that Belize made to the Nature Conservancy.
Michael Livermore 51:22
Got it and then and then they endowment was a kind of a second thing that happened
Lee Buchheit 51:25
was a promise that Belize made to its bondholders. That said we’ll take a portion, not all but a portion, but a portion that represented 1.3% of 2020, GDP will take a portion of the savings. And we will pre fund this account that the Nature Conservancy is going to manage and it will be used in perpetuity for environmental conservation. So that was a promise to the bondholders. And in return for that, or the request was that treat this if you want to put it in these terms as a kind of sweetener. In effect, we’re down to the last negotiation for how much the discount is. We think we can afford to pay only this much you would like more we appreciate that. But if you accede to our proposal, we’ll put this into the deal. Allowing you all to tell your shareholders, your investors, your regulators, and the general public that you are acquitting your environment, environmental social governance, promises and objectives.
Michael Livermore 52:51
Great. Yeah, this is I mean, it sounds like on its face to be a really wonderful thing, right? So that the Belize gets the much needed debt relief that it you know that it’s after the bondholders get paid back, you know, at a discount, they take, as they say in the business that they take a haircut. But part of that haircut comes with the ability to look spiffy so to speak and go out to the world and say that they’re fulfilling their environmental kind of commitments. And that’s good from a PR perspective. And, and The Nature Conservancy obviously is kind of engaged in this transaction to protect the environment and the environment gets. You know, there’s a there’s a broad environmental benefit. So, so it sounds I mean, you know, of course, I’m a skeptical law professor. So I wonder if it sounds too good to be true. So maybe that’s just Just one quick question. Is it too good to be true? Is there some something hiding here that you know, that if not the reasons to be skeptical that actually this this story is is as kind of a win win win as it as as it first appears? Well,
Lee Buchheit 54:07
the missing thing that we haven’t talked about is the loan that to the Nature Conservancy is extending to Belize represents more than just Belize’s risk. There’s a US government agency, the Development Finance Corporation, which is issuing a what they style a political risk insurance policy, which says that if ever Belize fails to pay. This US government agency will indemnify the Nature Conservancy and ultimately the bondholders who are buying the instrument that is is the origin of all of these funds, they will ensure that if if ever they have to get an arbitral award against believes that, that they’ll indemnify the bondholders for that. So that was an important, a crucial element in this. Belize, even even with retiring its bonds at a 50% discount still would not on its own have had the credit standing to sell a bond directly or indirectly, at a tolerable interest rate.
Michael Livermore 55:43
And then in this in this kind of backstopped insurance, but essentially by the US government, was that kind of made possible because of the environmental characteristics of this dealer? Is that the kind of thing that you know, kind of shows up in the background of of these restructurings more generally?
Lee Buchheit 56:03
No, it doesn’t. It’s it’s very rare. I think the US government is doing this, in part in support of its own professed environmental climate related program, all the things that you heard the President speak about in Glasgow, this week.
Michael Livermore 56:26
Sure, that’s really interesting. And it’s funny how, again, this is like the world of policymaking. You know, there’s the stuff that happens on the surface that we all see that’s that was big and splashy. And then there’s the very behind the scenes, you know, you know, underwriting or ensuring a transaction that, you know, is is very obscure to the general public, but where that can really have important policy consequences.
Lee Buchheit 56:49
Yes, indeed.
Mitu Gulati 56:51
well as thinking that’s, in some ways, such a key part of our prospects for doing these kinds of transactions in the future, Lee probably can’t talk about countries that are on the brink of defaulting tomorrow. But you know, you have countries like Sri Lanka, that I love dearly, and that have, you know, lots of coral reefs, but a huge debt stock. And if you had the international organizations, and countries like the US, and also the European Union, if they’re willing to say, look, we have something at stake here. If they engage in environmental protection, then there is a global good, that we get a benefit out of, they could really enable these debt restructurings to happen in, in a in a beneficial way in which we’ve never seen it happen before. I mean, the way in which these these debt restructurings have always happened in the past is, is what Lee described at the beginning, which is sort of, you know, the IMF makes this sustainability determination. And then the country has to, you know, do a lot of austerity and beat themselves on the chest and over the head about how terrible they’ve been. And then they have to behave well. Now we’re, we’re thinking about it, as, you know, as a global problem. It’s not the fault of individual countries or individual dictators. It’s just, look, we had COVID crisis. That was a global problem. And we have an environmental crisis. And we need to fix these with official international help. But I don’t know, maybe I’m too optimistic in the middle of being very pessimistic.
Michael Livermore 58:48
Well, it’s a good you need something to limit the pessimism to get out of bed in the morning. So So I mean, if we think broadly about this, I mean, is there any way I mean, you know, I care about the environment. So I teach in this area, and I write a lot about environmental issues. But I do wonder if there’s anything special about the environment here, is it possible that lenders could, you know, facility, the US government, for that matter, facilitate transaction where similar types of endowments that actually sounds like a particularly interesting kind of feature of this deal, were set up for things like infrastructure development or health care, or you know, backstopping the, the, you know, the government pensions, or kind of various components of a country’s fiscal management or or spending that kind of broadly speaking people recognize are good ways for countries to be spending their money and maybe areas where they under invest in is that is that is there a theoretical difference between those kinds of programs and the environment or is it just that the kind of political stars align better on the on the environmental expenditures.
Lee Buchheit 1:00:01
I think the latter, you could certainly use that technique to finance a variety of projects, that one way or another would be motivated by societal good. The environment, and particularly, the climate issue is a planetary problem. It will require a planetary solution. And therefore, remember what we’re talking about, particularly with commercial investors. You’re asking them to forego receipt of money that they’re legally entitled to, and no doubt about that. And they will tell you, Look, we have a fiduciary duty to the people who invest in our fund our shareholders, our investors, some of whom are you know, the fire department pincher formations. How? How do we justify to them leaving money on the table? Sure, it may do some good in your country. But if we give the money back to our investors, they’ll do some good in their country. So how do we the fact that climate and environment is so much in the forefront right now of being a planetary problem allows I think these financial intermediaries to justify to their own investors, that this is something that’s not, we’re not just benefiting, you know, the Republic of Ruritania, the borrower, we’re benefiting all of us. And add that shared sacrifice, I think is easier for them to justify to their own constituents. And that’s why I think, at the moment, and the political winds may shift, I think, to try to redirect these resources toward environmental conservation is easier.
Michael Livermore 1:02:37
Yeah, Mitu mentioned that the greenium, which I take to be a combination of green premium, and and I think the, what I take to be the greenium in this instance, was was five cents on the dollar 5%, which, which does, to me sounds like an awful lot. To be honest, I’ve always been, you know, somewhat skeptical of the kind of ESG conversation, I think there’s a lot of optimism about, you know, private companies engaging in these kind of broadly, socially beneficial programs. And I guess, the root of some of my skepticism is just that that’s just not what these companies are set up to do. They’re set up to make money for their shareholders, and that’s where they’re, they have legal obligations. And most of the folks I know, who work in the sector have felt kind of ethical obligations to maximize shareholder value. So it’s always been, I’ve always just been a little unclear to me, how much of this is just kind of PR, and how much of this is real. So five, five cents on the dollar? Sounds like it sounds like a lot. Does that seem like the kind of thing that we could expect in future transactions? Or again, is it a, is it a consequence of a particular political moment? Or maybe the, you know, the, I guess, the bond, I don’t know who the bondholders were, in this instance, if it was held, you know, kind of broadly by lots of different parties, or if it was kind of concentrated in a few actors that might make it a little easier to arrive in a negotiation.
Mitu Gulati 1:04:01
Mike, can I let me ask Lee, before you answer, let me add to Mike’s question, because I’m I’m a little puzzled and intrigued by what you got and relief. So one point, I think it’s what is important to realize here is that it’s not just that they got five cents more, or at least according to some of the press accounts. But they got something like 35% More of the votes. So Belize needed the votes of the creditors, it needed 75% of the votes of the creditors. to engineer this exchange, they only had about 50%, who had agreed and then there was the slew of articles in the financial press, who usually never report about Belize getting into yet another default but they had all these articles that are praised the deal, and talked about how cool it was and would have these beautiful pictures of scuba diving in the coral reefs. And and then they got another 35% of the votes in a matter of days. And I’m used to the sovereign debt restructurings taking years, years to get agreement and they got this in days. So Lee this is both amazing and also reason to think, Okay, how many countries are going to have such pretty coral reefs and you know, all the hedge fund people I know, they like to go to on vacation scuba diving. So they sort of imagine themselves as scuba diving by the pretty coral reef and saying, I saved this coral reef. But you know, if you’re talking about Lebanon’s debt restructuring, I don’t think hedge fund guys are going to Lebanon for vacation.
Lee Buchheit 1:05:50
guys, let me rain a little bit on this parade. I don’t think it’s possible in the Belize transaction to quantify exactly how much this was worth. And I don’t think you can say it was worth five cents, inevitably, in negotiation, you come down to the final bit, they’ll there’ll be a difference between the bid and the asked. In this case, because we were talking about a discount level, one side says I can afford to pay 51 cents and no more. And the other side says we have to have 60 cents. Some, some on the other side, say 65 cents. And so it’s a question of bridging the inevitable gap. And the way this technique can be used most effectively is for the sovereign borrower, when they reached that point in the negotiation, to say we can put a sweetener on the table that is not quantifiable. It isn’t money, but it is glory. It is a vindication of your mind wanted social environment principles. And therefore it is worth something to you. But I can’t tell you precisely how much and so that that’s the use of the technique. If the other side then says okay, we’ll accept these terms and won’t fight anymore. That’s the benefit but but how much absent that how how, how much the negotiation would have gone on for and what the final result would be no one will ever know. But there is a one other thing Mitu and I put an op ed into the Financial Times and in the spring with a a technique a different technique that is arguably applicable to a much much much broader range of sovereign debt workouts. And that was one which said that typically, a debtor country will have to issue a new debt instrument. In the restructuring the new debt instrument will reflect the debt relief that it has negotiated either in principle haircut a lower coupon or delay in maturity. So the country will now be obliged to pay in foreign currency the interest on the new debt instrument. And what we argued was that you could give the debtor country the option to discharge a portion of that foreign currency denominated stream of payments, discharge it in local currency. If the local currency is invested in a project that the creditors have approved, the logic of it is this, every creditor going into a sovereign debt workout knows that it has to give debt relief. The whole the whole raison d’etre of a debt restructuring from the creditor standpoint is that you want to improve the debtor country’s debt dynamics so that it can return to voluntary market operations and pay you back the residual amount of your claim. That’s why you do it. And therefore, from the creditors standpoint, the only issues are how do you do it and how much debt relief are you getting? Well, a country has an external debt problem because it lacks the foreign currency needed to repay its external debt, you can improve the country’s debt dynamics by saying, you can discharge a portion of that foreign currency denominated liability by by paying local currency that improves their debt dynamics. So it achieves the creditors objective, which they know they’re going to have to accede to one way or the other. But the creditor said, invest in an approved project, it could be environmental, it could be something else in the debtor country, good for the debtor, because it is saving precious foreign currency. And also, unlike a payment on an international bond, normally the payment goes out of the country, it’s gone. It’s a deadweight loss. In this instance, you’re taking some of that payment and discharging it by investing local currency in your own country. So that’s a that’s a technique, I think, that has far, far broader application. Belize was unusual, because it was a cash buyback. And you very rarely see those.
Michael Livermore 1:11:24
And the Nature Conservancy was involved see this third party? That was exactly, exactly Where’s what you’re describing could be worked out between just the debtors and the creditor. So I can imagine a criticism of this kind of deal, even though obviously, has a lot of advantages in terms of achieving debt relief, and, you know, seeing expenditures on you socially desirable projects. But one concern I can imagine folks raising is that there’s kind of a NEO colonial dynamic here, where you have, you know, hedge fund, folks, you know, who liked to scuba dive, you know, forcing Belize to spend more money on coral reef protection than it otherwise would? Or, you know, you know, creditors in general, you know, dictating how, how these sovereigns, you know, are going to spend their, their their money. And of course, there’s a there’s a north south dynamic here and a dynamic between developed and developing countries. And I, I’m curious if either of you have thoughts about, about that dynamic? Is that, is that an overblown critique? Or is there something to it?
Mitu Gulati 1:12:31
I think this is one of the reasons why the environmental part of ESG is much more likely to work. Because they’re, one can see it as a global public good that we are all going to benefit from together. To the extent the money is going into making sure they have these countries have better democratic institutions or treating women better, or, you know, have better judiciary, that the that all looks awfully like interference with their domestic structures, regardless of how odious we may think their domestic structures are. And we didn’t I mean, it’s sort of you know, Belize is an exceptional case. But I don’t think that we’ve heard any complaints that the coral reefs are going to be preserved. I mean, there’s something about the way in which people across the spectrum are enthusiastic about what happened. That I think is about the environment. And I don’t know, you’re the environmental experts. I don’t actually know how do you articulate why that work? I’d be curious as to what you think
Michael Livermore 1:13:57
I will answer that question in a second. Lee you got cut off right when you were about to start answering the question. So I wanted to kick it back to you. We’ve got a little bit for Mitu.
Lee Buchheit 1:14:06
there’s a there’s a simple answer to your question, Mike. The way you phrased it was, and I’m gonna paraphrase it. How do these foreign creditors get off telling the debtor government, how it should spend its money? And the fallacy in that sentence is it isn’t the debtor country’s money. It is the creditors money. The debtor country has solemnly promised to repay these creditors a certain amount of money over a certain period of time. That is the creditors legal entitlement. If the creditor says we will accept less money from you If you devote the the balance to this purpose, it is the creditors saying that who may use their money? And surely that’s within their entitlements to do.
Michael Livermore 1:15:18
Yeah, that’s interesting. That’s that’s that right. I mean, that that that makes sense. You know, I think that just to kind of Mitu’s point was kind of broadly that the maybe the environment and especially on some of the, you know, the optics here, that if you don’t even be under the kind of theory that you’re you’re offering that this is the really that we’re talking about is the creditors money, then, you know, maybe there’s something paternalistic, even of saying, you know, we’re willing to spend our money to benefit you, Belize, whereas it is more in keeping with with that theory, I think, to say, you know, we want to spend our money in a way that creates some joint value. And I think that’s probably a dynamic in the environment that maybe is a little different. Still, you know, reforming the, you know, creating a fund to for additional infrastructure investment, could be jointly beneficial if it puts a country in a better position to pay, pay its debt going forward. But maybe there’s something more immediate about the environments also very possible that it’s just a symbolic matter, that there’s kind of a feel good side of the environmental investment that a fund for infrastructure wouldn’t have?
Lee Buchheit 1:16:42
Yeah. Again, I think it goes back to the effort that’s being made now to convince every citizen of this planet, that we are jointly invested in the health of the planet. And that, for some of us, to exploit the environment, is injurious to all the rest of us. And therefore, you know, look, I grew up in Pittsburgh, Pennsylvania, a very long time ago. And I remember the local industrialists who took the position that that if God did not want me to pollute the Monongahela River, why did he put it in front of my factory?
Michael Livermore 1:17:41
Yeah, and it’s surprisingly, still people who think. But hopefully, that that’s us is somewhat more in a in the, in the minority than it was it was in the past. You know, it’s interesting that some of the cultural divides on on on environmental issues, and one of the things I think he’s also fascinating this area’s, you know, it would have been, you know, this is a broader thing. But I think that, you know, back back then, you know, where would the banks have been on a question like that, right? Where would the kind of the, the financial industry would have probably been more on the side of the, in the, in the industrialist by the river, and these days finances is, is a pretty green, culturally a pretty green group of people who, who are concerned about the environment, and that, you know, just as from a personal level, I think many people are. So I think that’s an interesting development that we’ve seen in the past, you know, recent decades.
Lee Buchheit 1:18:41
Yes, indeed. To set it in context, the phenomenon you just described is one in which a lender able to lend, let’s say, to a polluting steel mill, and earn a higher interest rate on that loan refrains from doing so, for these motivations. The phenomenon we’ve been discussing for the last hour is one in which a lender entitled to receive a higher interest rate voluntarily for bears from asking for all of it. If if the difference is invested in an approved project in the debtor country, it’s, it’s the same thing from the investor’s standpoint, in one case, he’s for bearing from collecting money he’s already owed and another case, he is forbearing from lending money that he knows he could lend and earn a higher return than he does to agree in project.
Michael Livermore 1:19:51
Yeah. And you know, we got I mean, again, even even with some skepticism on on this kind of ESG movement, I think You know, my my own view on this for what it’s worth is that it’s it’s ultimately it’s a it’s a sign of hopefully shifting politics and will likely be part of, you know, a broad social response to, to environmental problems. Well, I think that I’ve taken enough of your guy’s time I think we could continue talking for hours about these really fascinating issues. So I think we’ll I will just and with, with a big thank you for, for the conversation today. I’ve learned a lot. And it’s all really fascinating stuff. And also thank you for working on these really interesting issues and staying engaged on all of these. All these questions.
Lee Buchheit 1:20:43
Thanks, Mike. I enjoyed it very much.
Mitu Gulati 1:20:47
Thank you, Mike. That was a treat.
Free Range Podcast 