Nobody looks good in the Peruvian debt saga

 Gramercy Funds Management is a good operation. Its founder and boss, Robert Koenigsberger, was on the side of the angels in the Argentine debt dispute. It also did good work with Nicaragua, masterminding a 2007 exchange that wrote off 95.5% of $1.4 billion in debt. (Data from here.) Moreover, Koenigsberger is a smart fellow, a graduate in Latin American history from UCSD. It is the kind of firm I find difficult to dislike, let alone villify.

But it is in the wrong on Peru, where it is suing the country for $1.6 billion in defaulted bonds under the U.S.-Peru Trade Promotion Agreement.

I wrote about the history of the bond default here. Short version: Peru issued a bunch of bonds to compensate landowners as part of a land reform in 1968-69. In the 1980s it defaulted on those bonds, even though inflation was rapidly reducing them to nothing.

The Peruvian Constitutional Tribunal, for some reason, decided that letting inflation eat up the value of the defaulted bonds would be an unconstitutional seizure of property. Note, please, that American courts have rejected that notion. In the 1970s, unexpected inflation ate up the value of debts by more than a factor of two ... good luck getting an American court circa 1980 to tell you that the Fifth Amendment means that you should get double back from a debtor in default to whom you loaned cash in 1970. 

But anyway, the Constitutional Tribunal decided that creditors in Peru deserved more protection than creditors in the United States. 

Between 2006 and 2008, Gramercy bought the bonds cheap. (Background testimony here.) In a twist that makes my Luddite self happy, they had to actually go to Peru and buy up 9,773 individual paper bonds. I find that amazingly cool; it further increases my respect for Gramercy.

They are still wrong. But I like them.

Anyway, the Peruvian government stalled and stonewalled on settling the outstanding debt. In part, this was because Gramercy insisted that the right way to value them was by running them through the Peruvian CPI. Note, however, that Peru underwent a hyperinflation over that period: calculating the CPI for a hyperinflating country involves a lot of guesswork; it would be economic malpractice to simply run the value through the inflation index unless that index had been checked and recalibrated over multiple different base years to correct for the inevitable distortions. 

The Peruvian government understandably said no. The Constitutional Tribunal then stepped in again and proposed a very sensible way to value the bonds that involved neither a specious CPI calculation nor hiring a group of economic historian to carefully recalibrate historical price indices. (Obviously, I would have preferred the latter!) It suggested rather that the value of the bonds be converted into U.S. dollars, which would then be compounded at the contemporary rate on one-year U.S. Treasury obligations.  

OK, fine. In his testimony, Mr. Koenigsberger complains about that valuation method, but it is way more sound than running it through the Peruvian CPI. But his complaints are not groundless, because the Peruvian government used a bogus exchange rate to convert the nominal value of the bonds from gold soles into dollars. Frex, at a time when the black market rate of the gold sol was around 44 per dollar, the government used a rate of 1,029 per dollar.

So he has a point.

But the claim of $1.6 billion is too big. It involves making some heroic assumptions about the accuracy of the CPI under a long and extremely volatile time period. 

What would a fair value be?

Well, on page 5 of the arbitration filing, Gramercy implies that the bonds in its possession had a face value of approximately one billion gold soles around 1972.  The exchange rate in that year was around 43 per dollar. Using a 6% interest rate would value the bonds at $283 million in 2015; alternative methods (discussed here) would put it between   $190 and $321 million. If you assume that the bonds were not dated 1972 but rather 1969, the valuation range would increase to $222−$386 milion.

That is a lot more than Peru wants to pay, but it is a lot less than $1.6 billion. 

I were the Peruvian government, I would offer to settle for around $200 million. I have no idea what Gramercy paid for the bonds. Mr. Koenigsberger says on page 11 that Gramercy bought them at a discount, but we do not know at a discount off what. Face value? CPI-adjusted face value? Something else? I suspect, however, that the company likely paid rather less than $200 million for the bonds and should be willing to settle. 

Or they could ask Fat Crybaby to make a deal for them. He does deals, right! Gangsta lean straight from Queens, only not lean, not at all. 

Comments

[Carlos]

I like the buying up the paper too. It reminds me of stories I have heard about Vallejo scholars.

[Noel Maurer]

Vallejo scholars?

[Carlos]

The poet. If you want to study his life, you go to Peru on their terms; Peru does not come to you. Or so I've heard.

[Noel Maurer]

(Slaps forehead!) Of course! I was thinking of Mariano Vallejo and missing the connection. Blinkers, blinkers.

For readers who don't like cryptic references: Mariano Vallejo was one of the Californios who went over to the American side during the Mexican-American War. Vallejo helped write the new state constitution. He managed to protect a lot of his familial land via strategic marriages to American grandees; he then served in the Union Army during the Civil War. Fascinating man, albeit not as interesting as the César Vallejo, the poet.