Faculty of law blogs / UNIVERSITY OF OXFORD

A New Way to Impose Financial Sanctions on Dictators


Mitu Gulati
Professor of Law at the University of Virginia
Ugo Panizza
Professor of International Economics at the Graduate Institute Geneva and Director of the International Centre for Monetary and Banking Studies.


Time to read

5 Minutes

An age-old question in international finance is that of what happens to a despotic government’s debts when the despots are vanquished and the good guys take over. Do the good guys have to pay the debts of the despots?  There are both moral and economic arguments for why they should not.  Among other things, making it harder for creditors to collect on loans to despots should make them less inclined to support those despots in the first place.  International law though has stubbornly resisted calls for establishing an odious debt doctrine, for over a century now. The law is strict: governments inherit the debts of prior governments, regardless of their nature. 

However, Ricardo Hausmann, a professor at Harvard’s Kennedy School, may have produced a chink in the armor. In an Op Ed for Project Syndicate, he argued that investing in Venezuelan bonds was causing immense harm to the Venezuelan people, because it was helping finance a despotic regime that was privileging the repayment of bondholders over the welfare of its people. He advocated that JP Morgan (JPM) remove Venezuela from the emerging markets index (the EMBI+) so as to make Venezuelan bonds less attractive to the markets.

Unbeknownst to Hausmann, two days prior, on May 23, 2017, the asset management arm of Goldman Sachs (GSAM) had purchased $2.8 billion in bonds of the Venezuelan state-owned oil company, PDVSA. GSAM paid 31 cents on the dollar, for a total disbursement of about $865 million. Almost simultaneously, Venezuela’s international reserves increased by about $750 million.   

Putting two and two together, a series of press articles conjectured that GSAM’s bond purchase looked to be providing direct funding to the Venezuelan government, flying in the face of Hausmann’s plea for the government to be starved of capital. Adding fuel to the fire, GSAM appeared to have purchased its bonds at a price that was 25 percent below what other similarly situated PDVSA bonds were trading at. Hausmann appeared on CNN to talk about the “Hunger Bond” purchase and what he saw as “morally indefensible” behavior by GSAM. US Senator Marco Rubio tweeted “Today we learn that @GoldmanSachs just gave the Maduro regime in #Venezuela a $2.8 billion lifeline.” By then, protests had broken out outside GSAM’s office in New York, with many using “Hunger Bonds” on their placards. The term Hunger Bond became indelibly associated with the single issuance that GSAM had purchased on May 23, 2017.

That was just the tip of the iceberg. Institutional investors became scared that protesters would show up at their offices if they were seen as supporting the GSAM purchase, so they avoided it. Simultaneously, a number of big broker-dealers such as Credit Suisse announced that they would not be making a market for this bond

Things got worse for the Hunger Bond when investors, perhaps concerned that something really was wrong with this bond, began asking their lawyers whether there were matters hidden within the bond terms that they should be aware of. The lawyers, when they looked, found an issue buried in a couple of obscure bankruptcy cases – known as the Original Issue Discount or OID issue.[1] In this case, if this kind of OID claim were somehow to be recognized in the sovereign context and GSAM was determined to be the original purchaser (something they will strenuously deny), GSAM’s principal amount would become $865 million instead of the purported $2.8 billion.  

Last but not least, JPM, which had rejected Hausmann’s original request to exclude Venezuela’s sovereign bonds from the EMBI+ index, eventually excluded the bond. Hausmann had originally hoped that getting JPM to exclude Venezuelan bonds from the index would make those bonds less attractive to the large investors who marked their positions in comparison to the index, thereby drying up the market for these bonds. JPM did not react specifically to Hausmann’s request, presumably because neither the views of a Harvard professor nor human rights considerations were part of its criteria for what did or did not go into the index.  But what was part of JPM’s criteria was whether there was a meaningful market in the bond; and, thanks to the Hausmann Op Ed, there wasn’t one.  So, it got excluded. And because it was excluded, the big investors felt little pressure to go near it, even if it would have been a good buy. 

The end result: In the first week after the Hausmann Op Ed the liquidity of the Hunger Bond got killed and its price dropped by more than 16 percent while the price of comparable PDVSA bonds barely moved. In the roughly eleven months since, the price of the Hunger Bond, while moving closer to that of other PDVSA bonds, has remained below that of its comparators (for a detailed analysis, see here).  More important perhaps, no other transactions similar to the GSAM purchase have been carried out since then (as best we know) – even though we have heard from sources that multiple such deals had been in the works. 

To add emphasis to the foregoing, the Wall Street Journal reported that in early April 2018, at a time when no other Venezuelan bonds were receiving coupon payments, the holders of the Hunger Bond received theirs. Was this a signal from the Maduro government that it was giving priority to honoring those debts that had helped it stay in power? Assuming it was (or that there was a significant chance that it was), one might have expected that the price of the Hunger Bond would shoot above its comparators – after all, it was getting paid and the others were not. Instead, as the graph below shows, there was no positive bump for the Hunger Bond. Its price remained below that of the others. If anything, interviews with market participants tell us that, seeing the Hunger Bond show up in the headlines again as being beloved by a pariah regime, only enhanced the stigma associated with it. Nor were there public expressions of glee from GSAM; instead GSAM itself has now stated that it regrets having gotten anywhere near the Hunger Bond deal.

Professor Hausmann’s Op Ed managed to do what a century of academic and policy advocacy had failed at.  That is, increase the cost of capital for an arguably illegitimate government. The question though is whether this was the equivalent of the perfect storm or whether there are key ingredients that can be identified such that the Hausmann Effect can be replicated.

The story of the Hunger Bond might suggest a new possibility towards establishing a tool that can limit access to credit by despotic regimes. In a recent paper, we proposed a public ranking of individual bonds which lists potential ethical and legal problems. The idea is to create price penalties for bonds with ethical and legal infirmities and possibly increase the borrowing costs for regimes that, besides being despotic, adopt murky debt management practices. In the presence of this type of public information, few investors could claim to have bought a bond on the secondary market without knowing its illegal origin. This would depress the price of the bond in the secondary market and, hence, increase the cost of funds in the primary market.

Our proposal is modest; it does not completely starve a bad regime of funds, so long as that regime manages to be effective at issuing legally valid bonds.  But assuming that bad regimes are more likely to behave badly (in their debt issuance/management practices) than good ones, one can project that, if scrutinized carefully (as the Hunger Bond was) not only ethical, but also legal, infirmities will pop up; and at a higher rate than for the good governments.  This proposal has the advantage of not requiring any legal innovation or international consensus because it is based on existing law and legal principles. It is readily implementable and would be a step, maybe a small step, in the right direction. At worst, it would create incentives for the adoption of more transparent sovereign debt management practices.

[1] Basically, there are instances where the judge, perceiving that a certain creditor (usually one arriving in a near default scenario) has overinflated the size of its principal claim so as to dilute the claims of other (earlier arriving) creditors, will reduce the size of that misbehaving creditor’s claim to the amount it actually lent.

Ugo Panizza and Mitu Gulati are professors of international economics and law at the Graduate Institute (Geneva) and Duke University, respectively. A fuller treatment of the issues flagged here is in their recent article, The Hausmann-Gorky Effect.



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