Here's What Could Happen to Venezuela's Messy $170 Billion of Debt

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0:33Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Allaway. And I'm Joe Weisenthal. Joe, Venezuela. Venezuela week. So we've done the oil market. Yeah. We got to do the debt market. We got to do the debt market. I don't know anything about this stuff. So we got to do it. One of the reasons that I really like covering the debt market, bonds, is because I think we're used to thinking of bonds as contracts. Yeah. But I always like to think of them more as stories. Yeah, yeah. So they're full of all these narratives and embedded values and history. And there's actually a great quote from Margaret Atwood.

1:10She wrote this whole book called Payback on Debt. And she describes it as a story or a memory of who owes what and why. Yeah. And of course, if you're talking about a story or a narrative, those can change over time, right? Absolutely. I mean, so one thing I know is that just since Saturday morning and the early trading, I think the existing defaulted Venezuelan debt that's out there, I think it's rallied. I think it's gone. Oh, yeah. But I don't understand. Like, you know, you're trying to get the economy going again. You're going to make everybody pay for this money that was borrowed by someone who the international community regards to be legitimate as a dictator.

1:47If anything, shouldn't the creditors that facilitated his ongoing rise, shouldn't they have to pay? Not only should they not get paid back, shouldn't they pay the people of Venezuela extra for having subsidized someone that is widely regarded to be a criminal? We're calling this guy a narco terrorist. And yet, so it's like, shouldn't we punish the people who lent to him? Maybe you should be on the restructuring team, Joe. No, but it's true. So this is the debate. So you're right. Bonds have rallied. So there's Venezuelan sovereign debt. There's also debt issued by Pedevesa. And those have gone from like five cents on the dollar a few years ago to more than 30 cents.

2:25So people are already making money. And the bet here is that there is going to be some sort of restructuring and they're going to get more money. And of course, the creditors, the investors always want more. Meanwhile, there's a strong argument that the Venezuelan people should have their debt load alleviated in some way. Yeah, I'm in favor of a negative recovery. OK. All right. Well, we really do have the perfect guest to talk about all of this. Someone we've had on the show before, but it's been a while. We're going to be speaking with Lee Buchheit. He is a retired lawyer now. He's had a 40-year legal career, worked on more than two dozen sovereign debt restructurings, including Greece and Iraq.

3:09And that's going to be relevant to this conversation. So really the perfect guest. Lee, welcome back to the show. Thank you, Tracy and Joe. Good to be back. Maybe just to begin, can you sort of set out the scene of the creditors and the debt that Venezuela actually owes? Who owns those bonds and how much debt are we talking about? In total, probably now, the Venezuelan debt is someplace between$150 and$170 billion. Not all of that is bonds, and that's one of the issues that we should discuss. The bonds that we're talking about are principally Republic of Venezuela and Pedevesa bonds, roughly split 50-50.

3:59They were issued during the Chavez and early Maduro periods. They went into default, all of them, in the fall of 2017. You remember Mr. Trump in his first term imposed sanctions on Venezuela in August of 2017. The response was to have the bonds go into default, and they have remained in default since then. One of the difficulties that Venezuela will face in restructuring its what I call legacy debt stock is that there are all kinds of other liabilities that are not in the form of bonds. So there are unpaid trade creditors. There are holders of arbitration awards, chunky arbitration awards. There are people with blocked deposits in Venezuela.

5:01And so the restructuring, when and if it comes, will not be the simple, homogenous kind of restructuring that we're used to where there are bonds or in the old days bank loans. This is going to be a much more diverse creditor group. Is there a formal hierarchy that exists either in written law or in norms that sort of establish who comes first when we have these multitude of instruments? Or is it the type of thing where the conditions of each country, depending on what they are, et cetera, and maybe the conventions not necessarily written down the same way in formal law will help sort of determine that waterfall, I suppose?

5:45Nothing in law, but in convention, debts extended by the multilateral institutions, the IMF, the World Bank, the Inter-American Development Bank, that sort of thing, are treated as preferred creditors. So they will not be restructured in a formal sense. Once you come down from that level, then you have government debts. So, you know, debts extended by France, Germany, the United States, typically for export encouragement, and then commercial debts. And that can be bonds, bank loans, and these various other sorts of things. They all rank equally. Now, the government creditors would like you to believe that they have some kind of intermediate seniority, but in fact, they don't.

6:45So Joe touched on this in his emotional intro. I wasn't expecting to get so agitated, but it's like, we're calling this guy a narco-terrorist and they have to pay back his debts. It's ridiculous. There's an inconsistency there, sure. Lee, what about the old odious debt argument? This idea that if debt is issued by, I guess, an odious regime or an illegitimate regime of some sort, then maybe you don't have to pay it back at all. Yeah, this is a very sensitive area, Tracy. International law is very strict in saying that governments succeed to inherit the obligations of their predecessors, and no matter how different in political philosophy one administration may be from another.

7:33So the Bolsheviks take over from the Tsar in 1917. International law says the Bolsheviks have got to honor the debt. Napoleon Bonaparte honored the debts of the Bourbon monarchs that he followed. The exception, there are very limited exceptions to that. One of them that was first talked about in the early part of the 20th century was odious debts. In its original formulation, that meant a debt incurred by a dictatorial regime where the proceeds were not used for the benefit of the citizenry of the debtor country and where the creditor knew or should have known that the dictator was going to steal the money.

8:25So it was a pretty narrow category. It was resurrected in 2003 in the context of Saddam's Iraq. And there was a push there by, among others, many in the George W. Bush administration who wished to have Saddam's debts disavowed on the basis that they were odious. my view at the time was that that was ill-advised, that the doctrine of odious debt is sufficiently gauzy, that it is not something that the international community could have endorsed, because once you start down that road, there are a lot of sketchy characters out there whose debt you might want to disavow. So my view at that time was that Iraq would be able to achieve very significant debt relief without unfurling the banner of odious debt.

9:31Can you explain a little bit more what you see as the negative consequences of this notion of odious debt? Because I think a lot of people just maybe their heartstrings. They're like, yes, we should start using this principle. Saddam bad. The lenders to him probably had a reason to think he was a bad guy. What do you see as the cost of introducing this concept into sort of sovereign debt law or norms. Yeah, Joe, I entirely understand the emotional argument. It strikes most people as reprehensible that you could have a dictatorial, kleptomaniacal regime that signs a contract on behalf of the Republic of Ruritania.

10:15And when that son of a bachelor exits the stage, the poor people of Ruritania have got to repay that debt. That's the emotional argument. The other side of it is what constitutes an odious debt? You can have an odious regime that borrows money to build a children's cancer hospital. On the other hand, you can have a democratically elected regime that borrows money to finance a terrorist organization. What happened in the Iraq situation was the Bush team really would have defined it as any debt incurred by an odious regime. Okay, even if you take that, tell me, what is an odious regime? Is it one that makes war on its neighbors?

11:18Yes, probably. Is it one that is insufficiently attuned to environmental factors? Is it one that misprizes women? Tell me what's odious. And once you start down that road, pretty hard to find a regime that would, to everyone's satisfaction, be regarded as virtuous.

12:13us. key market themes each week. So whether you're managing a portfolio or leading a business, the Barclays Brief podcast can help you make smarter decisions today. Stay sharp, stay briefed, find Barclays Brief wherever you get your podcasts. Talk a little bit more about the Iraq restructuring, because this seems to be the previous sovereign debt restructuring that people are drawing a lot of parallels with Venezuela. So you have an oil producing country operating, as we've been discussing, under an authoritarian regime, to put it mildly. An alleged narco-terrorist. Yeah. Okay. Well, Saddam Hussein was never a narco-terrorist, was he?

12:56I don't know. I don't know. I don't remember. I was like 11. Narco-terrorism is probably one of the few sins that Saddam did not commit. Yeah. Okay. A point in his favor. Talk about the parallels here. Can we look at the Iraq sovereign debt restructuring, which I think ended up being something like 10 cents on the dollar for creditors? Is that the guiding light here? Would you expect Venezuela to follow a similar path? No, no. Iraq was unusual for this reason. You remember that George W. Bush, George II, and put together a coalition of 40-some countries. Saddam was ousted after a full invasion of the country.

13:43So the country was run by the coalition provisional authority, largely led by the United States. But the Brits were there and there were some others. They really did run the country, not in the way Donald Trump says he runs Venezuela. At that point, the coalition provisional authority really did run it. The Bush team really wanted that experiment to succeed. They wanted a stable, democratic Iraq right in the middle of the Middle East, someone that would support Israel when that became necessary. They wanted a bulwark against Iran. And they really wanted it to succeed. And their perception at the time, this is now 2003, 2004, was that this miasmic cloud of debt that Saddam had accumulated and ceased paying, by the way, in 1990, when the Security Council put sanctions on him, that debt stock would effectively keep anyone from investing in Iraq, lending it money, and so forth.

15:00So it was viewed by the Bush people as a major obstacle to the economic recovery of Iraq. And so they issued the mandate, deal with that debt stock in the most expeditious way possible. And as far as they were more of Joe's view that they didn't like Saddam Hussein and they didn't like anyone who lent money to Saddam Hussein. So they had little sympathy for the creditors. The United States had a very limited exposure. So this was a relatively harmless position for the U.S. government to take. But their initial proposal was to go and and say the debt is odious. Let's write off 100 percent of it.

15:54And we went to the Paris Club, the group that negotiates governmental, intergovernmental debt, I think with a proposal to write off 95 percent of it. In the end, 80 percent of it was written off. And that was absolutely extraordinary for a middle income country that sits on the fourth largest oil reserves in the world. But that was the mindset of the Bush people. I don't see Donald Trump having any particular solicitude for the citizens of Venezuela. His solicitude seems to be for the oil companies and perhaps for the U.S. government itself. That's interesting. I mean, who are we, I suppose, to speculate into Donald Trump's mind?

16:42Because on the other hand, you know, it's like oil is at$57 a barrel. Do the oil companies want to spend tens of billions of dollars rebuilding this? Do they want even cheaper oil right now, which would presumably happen if the taps turn on in Venezuela unclear? Setting all that aside, and maybe we'll get a little bit more to Donald Trump mind reading in a moment. What do we know about the holders of Venezuelan debt or PDVSA debt? Are we able to tell what type of institutions or entities are currently holding it? Joe, there's a function on the terminal called HDS, which stands for holdings, and you can look it up.

17:18OK, well, but I'll leave it to Lee. Yeah. Lee versus the terminal. No, no. It's mostly traded into the hands of hedge funds. OK. In January of 2019, Mr. Bush in his first term imposed a restriction that prevented U.S. residents from buying Venezuelan debt or even selling it to themselves. They could sell it overseas. And so some of it was sold off. But as Tracy said in her introductory remarks, in those days, this debt was trading seven, eight, nine cents on the dollar. But as with most sovereign debt restructurings, when the debt is in the form of bonds, freely tradable bonds, you don't actually know who owns it until such time as you make an offer to restructure it.

18:12Just real quickly as a follow-up, does it matter? Okay, maybe people don't have a lot of sympathy for hedge funds that are picking up distressed debt at two cents or five cents on the dollar, or maybe people feel differently about some entity that, I don't know, is just conservatively managing sovereign debt for widows and orphans, so to speak. But from the perspective of international law or New York law or sovereign debt restructuring law, does the composition of the creditor group bear into this at all? No. The claim is the claim. Where it is relevant, Joe, is in the negotiation of the debt.

18:52If I sit across from someone who paid 10 cents for their claim, and I offer them 20 cents, I'm a hero. But if I sit across from, in the old days, a banker who lent 100 cents, and I offer him 20 cents, I'm a heel. And so it plays into the negotiation in that sense. Would you expect the U.S. Treasury to be heavily involved in these negotiations, just in terms of the actual process, the legal process? Not nearly as much as George Bush's treasury was back in 2004 and 2005. The U.S. Treasury has always had an interest since 1982, when Mexico began the modern era of sovereign debt workouts. U.S. Treasury has always had an interest in seeing these problems dealt with in a consensual negotiated way.

19:55So I would expect if and when the time comes, they would encourage both the Venezuelan administration and the holders of Venezuela's debts to negotiate them in a consensual way. Well, actually, let me back up. I mean, we're talking about these negotiations and the market is clearly reflecting some expectations of a change. But does the arrest, the rendition of Maduro make that inevitable? Does this have to happen? Or is it possible that, again, because his vice president is currently - It's the same regime. It's the same regime, which Trump seems to be okay with because for whatever reason, we can only speculate what kind of conversations they've had in the background and so forth.

20:44But is there an inevitability to these negotiations? Is there a formal starting gun? Is there a reason that they ever have to happen? Or could Venezuela just stay on default and sort of model through without any resolution to the debt question? I don't think they can stay in default indefinitely, but there is no starting gun. As a matter of fact, what has prevented a restructuring of Venezuela's debt since 2017 has been the sanctions imposed by the U.S. government. Oh, yeah. This is funny. So you can't even sit down and begin to talk about a restructuring because you'd be in violation of sanctions.

21:22Yeah. And so those sanctions would have to be relaxed. And that decision ultimately sits with Mr. Trump. And he may or may not decide that the removal of Maduro is a sufficient basis on which to begin relaxing sanctions. But I don't think so. On the current path, he will want to see a complacent regime in Caracas. He has said as much. The president of Venezuela has got to be someone who follows the orders of Donald John Trump. And he said that if they are sufficiently complacent, then perhaps he will begin relaxing sanctions, perhaps allowing a debt restructuring to go forward. What has changed, and what will be different this time, is if you listen to the president's speech last weekend, he didn't talk about democracy.

22:28He made a passing reference to wanting to see Venezuela made great again. But his principal focus was on the oil companies. He wants them pumping oil and to that end, in effect, said, we will make sure that your claims for expropriation, which occurred in the Chavez era, are getting paid. And if he is true to what he said back when George Bush was in Iraq, Donald Trump criticized Bush for not having taken Iraqi oil to pay for the costs of the invasion. And so I expect he will say this time that Uncle Sam is entitled to be recompensed for the cost of keeping that naval armada in the Caribbean. So in a restructuring, the waterfall, which is normally a squabble between the citizens of the country and the creditors of the country, in this case, there may be people at the top and maybe U.S.

23:43government is at the very top and oil companies come next and then the squabble between citizens and creditors.

24:07One thing I've learned in my life and job is that lawyers are nothing if not creative. So I'm wondering, is there some sort of creative solution that could at least help perhaps on the margin the Venezuelan debt load while, I guess, preserving the goodwill, so to speak, of investors? So I'm thinking, you know, maybe maybe they get an extension instead of a haircut. Or maybe you have something like the Mexico situation where you have new loans, but those fall under different treatment to the older debt. Something like that. Yeah, look, a couple of things. First, the oil infrastructure in this country has been badly degraded.

24:52It's going to take two to five years, I think, of significant investment to bring that infrastructure up to the point where Venezuela is pumping what it was pumping, say, back in 2016, maybe 3 million barrels a day. So this is not going to happen overnight, that there's a huge influx of revenues. The second point, if Mr. Trump is true to his word, first dibs on those revenues will go to the oil companies who are making these investments. Third, some money is going to have to be used to have a discernible improvement in the lives of Venezuelan citizens. Otherwise, the regime that's in power will be very fragile.

25:50So you're talking about years in which most of this money is going to have to go places other than into the pockets of legacy bondholders. What I would expect, therefore, is that the bondholders will ask for what is generically called a value recovery instrument. This is a country that derives 95 % of its foreign currency earnings from the sale of a commodity oil. So the logical thing would be for the bondholders to say, give us an instrument that is a play on the oil market. That was done, by the way, in the early 90s during the so-called Brady Initiative. You had oil exporters, Mexico, Venezuela, Nigeria, and they sweetened their Brady restructurings by giving oil warrants that would pay off if oil exceeded a certain strike price in the future.

27:00Mexico's issued in 1990 had the strike price set at the enormous level of$14 a barrel. But I would expect that that will be the fudge factor in a Venezuelan restructuring. You're right that most payments will have to be deferred for quite a long time. But an oil instrument is likely to be part of the mix. When we're talking about international law with respect to sovereign debt, what law are we actually talking about? Because I know often they talk about New York law where a lot of bonds actually get issued or they go through the banks there, whatever. So when you talk about, okay, international law says this, that or whatever about what corpus of law are we actually talking about here and what law is relevant to the Venezuelan debt?

27:52Yeah. The debt instruments themselves will be issued under the law of a municipal jurisdiction. 95 % of sovereign emerging markets, sovereign debt is issued under the law of either New York or England. In Venezuela's case, it's all New York law. When I say international law, that's not the law applicable to the contract. That's really the law applicable to the governments that form part of the international system. So it will be New York law in the case of Venezuela. But just on this note, I know there's been chatter for a long time now about creating some sort of common framework when it comes to sovereign debt restructurings.

28:41Is that at all realistic at this point in time, or is it still sort of pie in the sky thinking? That idea was first broached back at the time of the Argentine default in December of 2001. And it was actually promoted by the IMF. They called it the sovereign debt restructuring mechanism. They reasoned as follows. in corporate debt workouts under bankruptcy, municipal bankruptcy laws, if a supermajority of the creditors agree to restructuring, their decision binds any dissenting minority. Sovereigns are not subject to a bankruptcy law. And so sovereign debt workouts have been characterized by holdout creditors, that is creditors that do not join a voluntary debt restructuring and seek to pursue their legal remedies.

29:43Argentina knows all about this. Yes, they do. So the IMF reasoned, well, what we need is a Chapter 11 for sovereigns. That idea died a political death because the Americans did not support it. But it continues to have some vitality. And bills have been introduced over the last few years into the New York legislature, one of them suggesting that perhaps New York, whose law governs many of these dead instruments, should itself put in place a kind of chapter 11 process. It hasn't gotten much traction. I don't think that that will. Why not? For a bunch of reasons. There are aspects of sovereign debt workouts that differ materially from corporate debt workouts.

30:45Among other things, the court does not control the foreign sovereign. Oh, of course. Foreign sovereign, we're going to liquidate you. We're going to take the keys to, well, I mean, keys to Venezuela. Kind of doing it. Exactly. They can't say we're going to replace the management. Sovereigns are sovereign. And that has always been the principal feature of sovereign debt workouts is that you're dealing with debtors who are not subject to any institutionalized bankruptcy regime. Therefore, we've had to rely on consensual workouts, but I'm not going to put too fine a point on the word consensual. Sometimes there's been encouragement.

31:37All right. We're going to have to leave it there, but it's been so good to catch up with you. Really the perfect guest for this particular topic. So thank you so much. Okay, guys. Thank you. Thanks, Lee. That was fantastic. So good. Thank you, Lee. Bye-bye.

32:04Joe, I really enjoyed that conversation. Lee has an incredible talent for explaining things in very, very clear language. But, you know, the thing that stuck out to me is, I guess, the contrast between sovereign versus corporate debt. You know, he talked about it at the end, this idea that you can't really have a sort of standardized bankruptcy process for a sovereign as you do with a corporate because sovereigns are sovereign. You can't have like a new equity. It's like, oh, and now the country goes to the equity holders, right? Because that's what happens in a company, right? So it's like, oh, you know what?