Sovereign Gold Bonds in 2019: Really?

Mark Weidemaier and Mitu Gulati

For a while now, we have been meaning to write about “sovereign gold bonds,” or “SGBs,” which the Indian government has been marketing under domestic law to residents of the country since November 2015. Gold bonds were supposed to have been a thing of the past. We’ve written previously about the U.S. government’s abrogation of gold clauses in both public and private debt in the 1930s. Last seen (to our knowledge) in government and corporate debt around that time, these clauses obliged the borrower to repay in either gold or currency at the option of the holder. (For detailed treatments, see here, here and here.) The point was to protect investors against currency devaluation. Thus, the famous case of Perry v. United States concerned U.S. government bonds that provided for payment of principal and interest “in United States gold coin of the present standard of value.” As the U.S. Supreme Court recognized, the promise sought “to assure one who lent his money to the government and took its bond that he would not suffer loss through depreciation in the medium of payment.” (An investor also would not benefit from an appreciation in the value of the currency, for payment was tied to gold coin of the “present standard of value.”)

The bonds in Perry were “Liberty” bonds issued to finance the 1st World War. The government therefore marketed the bonds as patriotic investments, although then, as now, marketers favored subtlety over heavy-handed appeals to emotion.

Regrettably for investors, it also turned out to be their patriotic duty to accept less than full payment.

Dysfunctional Sovereign Debt Politics in Lebanon, Italy, and [Your Country Here]

Mark Weidemaier & Mitu Gulati

Debt, like the full moon, is known to make politicians act strangely. There have been some good examples over the last few weeks, most recently in Lebanon and Italy.

Let’s begin with Lebanon. The country has a huge foreign currency debt stock, dwindling capital reserves, and one of the highest debt/GDP ratios in the world (here, here and here). Investors are concerned, and this is reflected in yields on Lebanese bonds and in the prices of CDS contracts, which reflect an estimated 5-year default risk of around 80%. Last week, Lebanon made a large principal payment on a $1.5 billion bond that had matured, and then turned around and borrowed more, issuing two new dollar bonds with a total principal amount of around $3 billion. These moves bought time, but at the cost of further straining the country’s scarce foreign currency reserves and adding to its debt burden. Why not instead simply ask for an extension of maturities on the existing bonds, buying time to devote resources to something other than debt service?

This head-in-the-sand approach is pretty typical. Politicians often delay debt restructuring far longer than they should. No award goes to the politician who recognizes and addresses a debt problem early, when it is still manageable. A politician who utters the word “default” is likely to get tossed out of office before the benefits of timely action become clear. And while in an ideal world, international financial institutions like the IMF might help produce better decisions, that rarely happens.

But it’s not just that the Lebanese government won’t acknowledge the problem. For some years, the government has delayed obvious reforms to its bond contracts that would have made a restructuring easier to manage.

Stupid Public Debt Tricks—The Alleged Seniority of Public Debt in Italy, the U.S., and Beyond

Mark Weidemaier & Mitu Gulati

Earlier this year, we wrote an article with Ugo Panizza and Grace Willingham about an unusual type of promise made by some sovereign nations, including Spain and Greece. The promise—sometimes enshrined in the constitution, other times in basic law—is that the state will pay holders of its public debt ahead of any other claimant. It is an unusual promise to make, in part because it doesn’t seem credible. (For separate discussion, by Buchheit, Gousgounis and Gulati, see here.)

Neither logic nor history suggests that a country in debt crisis will really treat public debt claims as senior to basic social obligations such as salaries for government doctors, police, and firefighters. When push comes to shove, responsible state actors have reason to favor the needs of the populace over the claims of financial creditors. And if this happens, it is not clear that local courts will step in to ensure that the government prioritizes debt payments.

On the other hand, perhaps these promises have some value? Even if financial creditors don’t get paid in full and ahead of other claimants, perhaps these promises lead them to anticipate slightly higher payouts in the event of a debt crisis and restructuring. Our article with Ugo and Gracie tries to test this hypothesis by asking whether governments that make such promises lower their borrowing costs. We find no evidence that they do. So why make the promise in the first place? There seems to be little upside, and the downside risk is that disappointed financial creditors will assert claims that could delay resolution of a debt crisis.

Speaking of which, we were going to talk about Italy, with its public debt of roughly 2.7 trillion euros. Here’s Article 8 of the Consolidated Act governing the public debt, in English translation available on the Department of the Treasury’s website:

The payments of public debt are not reduced, paid late or subject to any special levy, not even in case of public necessity.

Oh right, sure. If there is a dire need to restructure the public debt, Italian officials will calmly explain to the populace that public services will be slashed to the bone because the claims of financial creditors simply “are not reduced.”

Juno?

On Friday night I landed at JFK, after a very nice international insolvency conference at the University of Miami, and took a "Juno" home. Little did I know it would be my last time using the app. 

On Monday Juno announced it was shutting down, and on Tuesday it (and several affiliates) filed chapter 11 petitions. It blamed its demise on "burdensome local regulations and escalating litigation defense costs." The company has been marketing itself for several months, and its parent (Gett) intends to continue in the US as a business only ride service, operating in partnership with Lyft.

Now here's a question. The company notes that it "operated in New York, New York, where its headquarters are located." Where did it file its case?  Delaware.  Why?

Comments are open.

In the meantime, I guess I'm stuck with Lyft. And their drivers who insist on picking me up across the street from my apartment building.

 

Trump Administration Declares Open Season on Consumers for Subprime Lenders

The Trump administration has just proposed a rule that declares open season on consumers for subprime lenders. The Office of Comptroller of the Currency and the Federal Deposit Insurance Corporation (on whose board the CFPB Director serves) have released parallel proposed rulemakings that will effectively allowing subprime consumer lending that is not subject to any interest rate regulation, including by unlicensed lenders.

The Rigged Game of Private Equity

The Stop Wall Street Looting Act introduced by Senator Warren has the private equity industry's hackles up. They're going to get a chance to say their piece at a House Financial Services Committee hearing on Tuesday. The bill is a well-developed, major piece of legislation that takes a comprehensive belt-suspenders-and-elastic waist band to limit private equity abuses: it's got provisions on private equity firm liability for their portfolio company obligations, limitations on immediate looting capital distributions, protections for workers and consumers in bankruptcy, protections for investors in private equity funds, and of course a reform of private equity's favorable tax treatment. The bill shows that Senator Warren truly has the number of the private equity industry.

 

In this post I want to address the provision in the bill that seems to truly scare parts of the private equity industry: a targeted curtailment of limited liability for the general partners of private equity funds and their control persons. This provision terrifies some private equity firms because it requires private equity to put its money where its mouth is. The provision is essentially a challenge to private equity firms to show that they can make money off of the management expertise they claim, rather than by playing rigged game with loaded dice. 

 

Private equity claims to make money by buying bloated public companies, putting them on diets to make them lean and mean, and then selling the spiffed up company back to the public. The whole conceit is that private equity can recognize bloated firms and then has the management expertise to make them trim and competitive. If true, that's great. But as things currently stand, it's near impossible for a private equity general partner—that is the private equity firms themselves like Bain and KKR—to lose money, even if they have zero management expertise. That's because they're playing a rigged game. The game is rigged because there is a structural risk-reward imbalance in private equity investment. That's what the limited liability curtailment in the Stop Wall Street Looting Act corrects. Here's how the private equity game is rigged:  

Private Equity’s Chicken Little Dance

The private equity industry is lashing out at Senator Warren’s Stop Wall Street Looting Act with some pretty outlandish claims that rise to Chicken Little level. According to an analysis by the US Chamber of Commerce's Center for Capital Market Competitiveness, the bill will result in the $3.4 trillion of investment provided through private equity over the past five years entirely disappearing from the economy, along with as much as 15% of the jobs in the US economy disappearing.    

 

I cannot sufficiently underscore how laughably amateurish this claim is. I’ve seen some risible financial services industry anti-regulatory claims before, but this one really takes the cake for extreme hand-waving. I expected better from the Masters-of-the-Universe.

 

Here’s why the private equity industry’s claims are utter bunkum.

Bankruptcy Filing Rate Remains Flat

Every month I see stories about the bankruptcy rate moving up and down. The truth is that the U.S. bankruptcy filing rate has remained flat over about the past four years.

The table to the right shows the total number of bankruptcy filings, consumer and business, using data from Epiq. For 2019, the figure is an estimate. For each of the past two years, 85.3% of the yearly bankruptcy filings had occurred by October 31. Extrapolating from the 648,000 bankruptcy filings through October 31 of this year, the total number of bankruptcy filings by year end will be about 760,000. That is not much different than the 767,000 in 2017 or the 755,000 in 2018.

Call for Papers -- 2020 Boulder Conference on Consumer Financial Decision Making

The inimitable John Lynch emailed to let me know that the call for papers is open for the 2020 Boulder Conference on Consumer Financial Decision Making, to be held from May 17-19, 2020. Much more information, including how to submit an abstract for consideration, appears on their web site.

If you are interested in the sort of content we have at Credit Slips, this conference is for you. Several of the Credit Slips bloggers, including myself, have presented at the conference. The papers and discussions are high quality. The setting at the St. Julien Hotel is fantastic. And, after a day of conference discussions or when the conference is over, you are in Boulder, Colorado, in the spring. If you have a paper that fits, I highly recommend submitting.

What a Local Traffic Snafu Teaches About Artificial Intelligence in Underwriting

The DC suburbs are a case study in NIMBYism. Lots of communities try to limit through-traffic via all sorts of means:  speed bumps, one-way streets, speed cameras, red-light cameras, etc.  The interaction of one of these NIMBYist devices with GPS systems is a great lesson about the perils of artificial intelligence and machine learning in all sorts of contexts.  Bear with the local details because I think there's a really valuable lesson here.

Coercive "Consent" to Paperless Statements

If you've logged on to any sort of on-line financial account in the past few years, there's a very good chance that you've been asked to consent to receive your periodic statements electronically, rather than on paper. Financial institutions often pitch this to consumers as a matter of being eco-friendly (less paper, less transportation) or of convenience (for what Millennial wants to deal with paper other than hipsters with their Moleskines). While there is something to this, what's really motivating financial institutions first and foremost is of course the cost-savings of electronic statements. Electronic statements avoid the cost of paper, printing, and postage. If we figure a cost of $1 per statement and 12 statements per year, that's a lot of expense for an account that might only have a balance of $3,500—roughly 34 basis points annually.

I'm personally not comfortable with electronic statements for two reasons. First, I worry about the integrity of electronic records. I have no way of verifying the strength of a bank's data security, and I assume that no institution is hack proof. Indeed, messing around with our financial ownership record system would arguably be more disruptive to the United States than interference with our elections. FDIC insurance isn't very useful if there aren't records on which to base an insurance claim. Of course, the usefulness of a bank statement from two weeks ago for determining the balance in my account today is limited too, but if I can prove a balance at time X, perhaps the burden of proof is on the bank (or FDIC) to prove that it has changed subsequently. 

Now, I recognize that not everyone is this paranoid about data integrity. Even if you aren't, however, paper can play an important role in forcing one to pay attention to one's financial accounts, and I think that's valuable.  I am much more likely to ignore an email than I am a paper letter in part because I know that the chance the paper letter is junk is lower because it costs more to send than the spam.  As a result, I look at my snail mail, but often let my e-mail pile up unread. And even when I read, I don't always click on the link, which is what would be in an electronic bank statement.  Getting the paper bank statement effectively forces me to look at my accounts periodically, whereas an emailed link to a statement wouldn't. And monitoring one's accounts is just generally a good thing--it helps with fraud detection and helps one know one's financial status.  

So here's where this is going:  I've got no issue if a consumer wants to freely opt-in to electronic statements.  But the way my financial institutions communicate with me when I go on-line involves really coercive choice architecture. One bank presents me with a pre-checked list of accounts to be taken paperless, such that to not go paperless I have to uncheck several boxes.  I am essentially opted-in to paperless. Another bank has a prominent "I agree" button without an equivalent "I decline" button-the only way to decline paperless is to find the small link labeled "close" to close the pop-up window. "Consent" in this circumstances strikes me as iffy. This strikes me as an area in which regulators (I'm looking at you CFPB) really ought to exercise some supervisory muscle and tell banks to cut it out. If folks want to go paperless, that's fine, but don't try and coerce them. Doing so is contrary to the spirit of the E-SIGN Act at the very least and might enter into UDAAP territory.

Bankruptcy Future Claims—Elizabeth Warren Edition

Welcome to Credit Slips, the rarified world of “self-described bankruptcy nerds.” Today we’re looking at Future Claims—Elizabeth Warren Edition.

Now, it’s not every day that our humble group blog gets discussed in the New York Times. But as our former-co-blogger Elizabeth Warren continues to rise in the polls, the media and her opponents are taking a renewed interest in the bankruptcy consulting work she did when she was a law professor. Just recently, the New York Times ran a lengthy article on her past consulting workthat even referred our little “bankruptcy nerd” blog. (You might note that we now also offer sovereign debt, financial regulation, and side salads. Come for the bankruptcy, stay for the pie.)

The NY Times piece discussed several cases that Elizabeth worked on, but it failed to clearly articulate the core bankruptcy principle that Elizabeth was fighting for that runs throughout most of the cases highlighted in the article and how Elizabeth’s work was consistently about making the economy and the bankruptcy system work for employees of companies in distress, retirees, and folks injured by a company’s product. To suggest otherwise is ridiculous and fundamentally misunderstands how the bankruptcy system is supposed to work.  

Purdue Pharma Examiner?

The US Trustee should move for the appointment of an examiner in Purdue Pharma's bankruptcy. That's what Jonathan Lipson, Stephen Lubben, and I wrote in a letter to the US Trustee for Region 2 this week.

Purdue is a case that seems to cry out for an examiner.  There is unique public interest in the case because it is so central to the story of the opioid crisis—the major domestic public health challenge of the last decade. In particular, there are real questions about exactly what Purdue and its owners knew about the problems with opioids and when.  Was Purdue was deliberately pushing a product it knew to be harmful? Did its owners, the Sackler family, siphon off substantial funds that could go to remediate opioid harms through fraudulent transfers, as alleged? And can Purdue's current management or the Official Creditors Committee be relied upon to get to the bottom of these questions?  

An examiner--particularly one wielding subpoena power and the power to administer oaths--could go a long way to establishing just what went on at Purdue, and that will help set the stage for a resolution that will be more broadly accepted as legitimate because everyone will be operating on a common factual basis from the examiner's findings. Moreover, an examiner's report is in effect a public accounting of what happened at Purdue. Absent such a public accounting, bankruptcy can become a whitewash:  no trial, no public introduction of evidence, no finding of guilty or not guilty, just claims estimation, a plan and a vote, and then some cash being paid out. That's fine for your run-of-the-mill bankruptcy case. There's really no public interest in why Shloyme's 7th Avenue Garmento Emporium ended up in the chapter. But when a case involves a major public health issue like Purdue, it's reasonable to demand more from the bankruptcy system. Purdue (and possibly other constituencies) will surely object to an examiner motion, be it from the Trustee or from other parties in interest, but I have trouble thinking of a case for which an examiner would be more appropriate.  

 

Interpreting Argentina’s “Uniformly Applicable” Provision and Other Boilerplate

Mark Weidemaier & Mitu Gulati

Over the past week, we’ve discussed various uncertainties over how to interpret the new “uniformly applicable” standard added to aggregated Collective Action Clauses starting in 2014 (here and here). Anna Gelpern’s recent post neatly clarifies some of the issues and provides crucial background on the “uniformly applicable” provision. Oversimplifying, the “uniformly applicable” standard was an attempt to assuage creditor fears that sovereigns would exploit aggregated voting to discriminate among bondholder groups. The intent of the clause was to ensure bondholders got roughly—but as Anna points out, not literally—the same treatment. Our prior posts have focused on how the text of the standard might be stretched to forbid certain unanticipated restructuring scenarios, especially when courts perceive the sovereign to be acting irresponsibly or vindictively. That’s precisely the situation in which courts are willing to stretch the meaning of contract text. It’s what happened to Argentina in the pari passu litigation.

In this post, we focus on the broader question of how courts should approach the interpretation of bond clauses like this one. When presented with disputed but plausible interpretations of a text, courts normally try to uncover the intent of the contracting parties and interpret the contract consistently with that intent. (This is a generalization, but accurate enough for our purposes.) But bonds and other (largely) standardized contracts are different. For the most part, the point of standard language is to ensure standard meaning. That goal isn’t served, and can be undermined, when courts inquire into the subjective intentions of the parties to any particular contract. But if their intent isn’t relevant, whose is? Greg Klass, in a new article “Boilerplate and Party Intent,” offers an insightful way of thinking about these problems.

Argentina’s “uniformly applicable” standard offers a good example of the difficulty. The government officials responsible for negotiating sovereign bond deals generally want to adhere to a set of “market standard” non-financial terms. They have only a vague sense of the specific language of most contract terms. Likewise, many investors have told us that they paid little attention to the “uniformly applicable” language in Argentina’s bonds until Argentina went into crisis. They knew the bonds had CACs and, more concretely, that the clauses featured aggregation provisions. But, beyond that, they didn’t know the details. So a search for the intent of the parties—defined as the bondholder and the government—won’t turn up much of value. (In theory, underwriters are part of the equation, but their incentives are to get the deal done – and using standard forms helps get deals done.)