Veteran Lawyer Says Emerging-Market Debt Is Headed for Trouble

(Bloomberg Markets) -- For developing countries facing down creditors, Lee Buchheit was the cavalry. During his 43-year career at Cleary Gottlieb Steen & Hamilton LLP, the quick-witted restructuring lawyer gained a reputation for shattering investors’ dreams of sky-high returns.

Buchheit, 68, brought arcane legal terms such as collective action clauses and asset protection orders into modern debt markets. He deployed the former to spur a settlement for Greece, enabling a supermajority of creditors to forge an agreement that was binding on all bondholders. Buchheit applied the latter in Iraq to force U.S. investors to divest from local assets.

Veteran Lawyer Says Emerging-Market Debt Is Headed for Trouble

Now retired from Cleary, the Pittsburgh native has a frightening prognosis for the coming decade: He foresees the biggest string of defaults since the early 1980s. He blames the rise of bullet bonds, noncallable debt instruments that pay back the entire principal at the final maturity date. In an interview, Buchheit spoke about what he’s learned over his career and the restructurings he sees on the horizon.

BEN BARTENSTEIN: How did you get involved in the debt restructuring business?

LEE BUCHHEIT: I realized that my long-term survival in the legal profession would require me to find a practice area that would offer a degree of continual intellectual refreshment. The sovereign practice does that. Each country is different. Not just in their financial condition but also in their culture, geopolitical leverage, and internal politics.

BB: And not without some drama. You almost had your passport revoked, right?

LB: That’s right. I was in Quito [Ecuador] in either 1999 or 2000 and had to get back home. Someone, I think it was the finance minister, said, “No, no, you have to stay.” And I said, “No, I really have to go home.” And they said, “You know we have the power to take your passport.” I said, “Yeah, but if you do that you won’t have a friend in me anymore.” Eventually, they let me go.

BB: Did you ever feel in danger on the job?

LB: Sometimes. In one Asian country we privatized the state airline. We were on the deal team waiting for the closing. Everyone got a death threat under their hotel door. It turned out there was a group of employees of the airline who’d taken advantage of flights to put narcotics in the nose of the airplanes and weren’t happy about new owners taking over.

BB: Tell me about your suitcase.

LB: Well, I’d be on the road 50 to 60 percent of the time. The suitcase is always packed. My first rule is never check a bag. Then you’re not hostage to the airlines if they cancel or delay the flight. For me it’s usually three shirts, three ties, underwear, socks, a shaving kit, and cuff links. Then I have a lot of sleeping pills, and caffeine in the morning.

BB: What’s one of your biggest lessons from the field?

LB: When I first got involved with the Philippines in the 1980s, Ferdinand Marcos was still in power, and I watched Cory Aquino’s rise to power. That was quite exhilarating. There was also a lesson. The problem I found—I went through that in the Philippines and when [Iraqi leader] Saddam Hussein was overthrown—is the people who’ve been suffering under some regime assume that once the son of a bitch is gone, everything will get better right away. Of course, the higher those expectations, the more painful it is when they crash down. No government, no matter how well-intentioned, can cure all the ills in a society.

BB: What’s the problem with bullet bonds?

LB: When we moved into the bond era in the 1990s, the market actually preferred trading bullet maturities, maturing 5, 10, or 100 years out. When that date comes, the country may not have access to the market at an interest rate it can afford. Risks are aggravated if borrowing was done during a commodity boom. It’s like having a pal who’s on a diet, and just before they take a bite of their chocolate éclair, you say, “A moment on the lips, a lifetime on the hips.” You borrow today, and the liability goes on the hips.

BB: Who’s most at risk?

LB: I’m worried about the 20 or so countries that never before came to international bond markets and were able to issue inaugural bonds this past decade. In sub-Saharan Africa you see a number of countries that will have problems, particularly if interest rates continue to rise or a withdrawal of quantitative easing pulls liquidity out of the market.

BB: How do politics contribute to this problem?

LB: That’s always been a characteristic of sovereign finance. The people who borrow are rarely the ones who pay it back. Then you have the obvious tension when there’s a government in place and a great crisis. The opposition wants to see the government fall on its face. A finance minister from an African country once came to me before defaulting. This was a preemptive restructuring. When I finished meeting with him, I said, “Let me express my admiration for dealing with a problem that’s inevitable, but you’re doing it earlier.” And he said, “Son, we don’t have an election for another eight months. Don’t you think if I could hand this bag of garbage to the next administration I would do it? But we won’t last eight months.” The domestic politics make this job so fun.

BB: What role do investors play?

LB: Well, a modern bond investor doesn’t normally expect to be there when the debt matures either. Investors can say, “I’ll buy the bond with a bullet maturity, and when that day comes, when they refinance it, I don’t expect to be there. I’ll have sold it.” The one trait shared by every hedge fund investor is they know they’re smarter than everyone else. They’ll say, “I can perceive the early warning signs of trouble and sell to some other poor devil.”

BB: So what’s your outlook now?

LB: Another bout of emerging-market sovereign debt problems may be in the offing. Interest rates have come up from their historic lows. QE programs are being wound down. The commodity boom is well off its highs. A lot of debt, both corporate and sovereign, was put on the books during the sunny days.

Bartenstein covers emerging markets at Bloomberg News in New York.

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