On September 5, the highly-respected Venezuelan economist Ricardo Hausmann, writing with his colleague Miguel Angel Santos, threw a bomb into the sovereign-debt world with an excellent, trenchant column headlined “Should Venezuela Default?” The column sparked a major international war of words: Venezuela’s president, Nicolas Maduro, gave a speech calling Hausmann a “financial hitman” and “outlaw”, while Hausmann, in turn, told Bloomberg News that Maduro’s speech was “the despotic diatribe of a tropical thug.” Fun times!
I suspect, however, that maybe Maduro was protesting just a little bit too much, and that he was annoyed mainly because Hausmann hit very close to the mark. Note the timing, here: Maduro didn’t respond immediately, he only responded after Reuters broke the news that Venezuela has hired Lazard to sell all of its assets in the US, including Citgo.
Why would Venezuela want to sell Citgo, which has always been a source of great national pride?
Well, it could certainly use the $10 billion, but there’s another reason, too. If Venezuela defaults on its bonds, then bondholders will seek to attach any assets that Venezuela holds in the US. Assets, that is, like Citgo. But if Venezuela sells Citgo before it defaults, and then moves the proceeds to its account at the New York Fed, at that point the money is untouchable. Which means that if you’re a bond trader, you’re going to be highly sensitive to the news that Citgo is on the block — especially if that news comes out just days after Hausmann’s column. Since no president likes to see bond traders making such inductions, you can imagine why Maduro got angry.
But here’s the thing: Hausmann is right. For bond traders, and for Maduro, and even for the purposes of Hausmann’s own headline, the question of default is a binary one: should Venezuela, which is not currently in default, go into default? And because 99% of talk about default is filtered through journalists who are deeply steeped in financial markets, the term has basically come to have a single, narrow meaning: default is a bond default.
I’m not ashamed to be one of those journalists myself — indeed, I’m a particularly geeky one when it comes to sovereign debt. (I dare you to find a nerdier video on the subject than this one.) I’ve been reading and writing about sovereign bonds for almost 20 years now, and I occasionally claim real expertise on the subject of sovereign debt restructuring. I can tell you about the difference between bonds and loans, or between New York law and London law, or whether it’s possible to use a rolling interest guarantee to effectively pass an international financial institution’s preferred creditor status across to a private-sector structured bondholder. Once upon a time, for about 5 minutes, I even understood how the Brazilian C bond worked.
For someone like me, then, it’s second nature to care almost exclusively about whether a country has defaulted on its bonded debt: no other kind of default really matters. But Hausmann is absolutely right: default is much more than bond default. Venezuela is in default on all manner of obligations. And in such a situation, any responsible government must start prioritizing. Why, exactly, should they bend over backwards to make sure all of their foreign bondholders are paid in full, when sick Venezuelans are dying for lack of medicine?
Severe shortages of life-saving drugs in Venezuela are the result of the government’s default on a $3.5 billion bill for pharmaceutical imports.
A similar situation prevails throughout the rest of the economy. Payment arrears on food imports amount to $2.4 billion, leading to a substantial shortage of staple goods. In the automobile sector, the default exceeds $3 billion, leading to a collapse in transport services as a result of a lack of spare parts. Airline companies are owed $3.7 billion, causing many to suspend activities and overall service to fall by half…
The fact that [t]his administration has chosen to default on 30 million Venezuelans, rather than on Wall Street, is not a sign of its moral rectitude. It is a signal of its moral bankruptcy.
Why would a populist, leftist government like Maduro’s be happy shipping billions of dollars to foreign bondholders while its own citizens are literally dying as a result of Venezuela not paying its pharmaceutical importers? There are many answers to that question, some better than others; the Citgo situation, for instance, explains why Maduro would want to get his foreign-asset ducks in a row before embarking on a bond default. What’s more, as heir to the sainted Hugo Chávez, Maduro doesn’t want to default on bonds which Chávez issued.
But that doesn’t mean the rest of us should unthinkingly adopt the definition of default used by traders of credit default swaps. Indeed, back during the sequester, last year, I wrote a post headlined “The default has already begun,” making much the same point about the US. With apologies for quoting myself:
The best way to look at this, I think, is that there’s a spectrum of default severities. At one end, you have the outright repudiation of sovereign debt, a la Ecuador in 2008; at the other end, you have the sequester, which involves telling a large number of government employees that the resources which were promised them will not, in fact, arrive. Both of them involve the government going back on its promises, but some promises are far more binding, and far more important, than others.
Right now, with the shutdown, we’ve already reached the point at which the government is breaking very important promises indeed: we promised to pay hundreds of thousands of government employees a certain amount on certain dates, in return for their honest work. We have broken that promise. Indeed, by Treasury’s own definition, it’s reasonable to say that we have already defaulted: surely, by any sensible conception, the salaries of government employees constitute “legal obligations of the US”.
So to agree with Hausmann is not to say that Venezuela has already joined the ranks of scofflaw countries like Argentina — it’s to say that Venezuela has joined a club which boasted even the USA as a member, very recently. It’s still not a club which any country wants to join — but the more that you default on various sovereign obligations, the less of a big deal it becomes if and when you eventually default on your bonds.
America eventually cured its default, and never graduated to defaulting on Treasury bonds. But Venezuela’s problems are harder to fix. And at some point, it simply won’t make sense to spend desperately-needed billions on foreign bondholders any more. Indeed, if you ask Ricardo Hausmann, he’ll tell you that not only is Venezuela there already, but that even the technocrats IMF would recommend a sovereign bond default at this point.
For all that it’s embarrassing and politically perilous for any government to default on its sovereign debt, then, I suspect that a fully-fledged default in Venezuela is now only a matter of time. Right now bondholders are probably safe, or safe-ish. But if and when Citgo is sold, alongside Venezuela’s other foreign holdings, I can’t imagine that the country will continue to pay its coupons in full. Indeed, Venezuela owes it to its citizens not to.
Felix Salmon is a senior editor at Fusion