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Commentary

Ecuador chooses to default. Conspiracy Theory Ahead.

Sometimes I just don’t understand.

Ecuador has chosen to default on a 30.6 million dollar payment on its bonds.

Which is surprising, because it has 5.65 billion dollars in cash. The total amount of bonds outstanding that it defaulted on is worth only $510 million. (2012 expiry)

Rafael Correa, Ecuador’s president and a leftist, has said he wants to restructure this debt. But given the debt has been restructured twice earlier, bondholders are unlikely to let Ecuador off the hook again.

Ecuador is rich in oil and commodities, both of which have taken a big hit in the recent past, and both of which are common with it’s neighbour Venezuela. But that seems to be more than what they have in common – Venezuela is the biggest writer of credit default swaps, and thus, default protection, on Ecuador’s bonds. Hugo Chavez is a friend of Correa, but I don’t think that friendship lasts the $510 million.

And further complicating the equation: Ecuador gave up it’s own currency to adopt, get this, the U.S. dollar. Which means whatever it owns is effectively attachable by the U.S., where the legal battle will be fought.

They fired their last good set of lawyers during the bond restructuring in 2000, and they’re fighting well established funds like Greylock and Elliott, which supposedly know their law upside down.

Their debt trades at some 20 odd cents to the dollar. If Venezuela is paying for any default, you can bet that the bondholders love the concept – buy at 20 dollars, and get 100 cents either from Ecuador through it’s dollar holdings (the only cash it will own is USD) or get it from Venezuela. Obviously the deal will be to push for the default.

But what if this is just a ruse – to push up the CDS price higher and higher that allows Venezuela to sell protection at an even higher rate, and then Ecuador doesn’t default? Chavez is friends with Correa, supposedly, so a plan like this can be done over a good cup of Columbian coffee (or, over other things Columbia is famous for). Think about it: Ecuador’s CDS trades at 4200 bps – 4.2m to insure 10 million. (pounds)

And they’ve done that before. In Feb 2007, Ecuador first refused a debt payment and later agreed to pay it all back at the end of a 30 day grace period, causing huge fluctuations in the bond prices. (btw, the 30 day grace period for the current payment ends tomorrow, on Dec 15) It might just be that Ecuador, or indeed, Columbia is buying the 21 cent bonds; stiffing someone in the process.

The eventual plan may be to keep bond prices obscenely low so they can be bought and held and to keep CDS prices high. If eventually when the oil bust and commodity depression takes its toll both countries may raise their hands; and given everyone’s asking for a bailout now, it is likely to be given some consideration. If not, heck, profits will be made by either country.

That countries can default came to our notice suddenly with the news about Iceland and Pakistan. That a country can choose to default even if it has the cash is now possible with Ecuador. That banks can loot the taxpayer is also obvious. That everyone except the automakers will get away with it? Yes.

Trust – that flimsy, slimy little word.

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