Iraq: Freeing Its Bonds

Courtesy of The Boston Globe, an article on the performance of Iraqi bonds.  As the report notes:

“…Some count the kidnappings. Others count the suicide bombs. Still others count the deaths of US soldiers. But, in the saga of Iraq’s slow struggle toward normalcy, Robert Smith keeps track of something far more obscure: the price of Iraqi government issued bonds.

Smith, one of Boston’s most intrepid investors, has made his fortune betting on the world’s most dangerous places. Dubbed the “Indiana Jones of International Finance,’’ Smith buys IOUs from governments so unstable that few others will touch them.

From an office that overlooks Boston Harbor, Smith can recall when Iraq looked like a terrible gamble, as sectarian violence raged and the country slid toward a civil war. But now, a week after Iraq’s historic election, his bets are paying off: The price of Iraqi bonds has doubled in the last year, recently hitting their highest value ever.

“Iraq has the potential to vault past other countries’’ to become a top oil producer, said Smith, a 70-year-old debt merchant whose recent book, “Riches Among the Ruins,’’ details his investment adventures.

The story of Iraqi bonds is, in many ways, the story of the troubled nation itself. Issued to clear $2.6 billion of Saddam Hussein-era debts, their value reflects the ebb and flow of war, declining when the insurgency rages and rising as violence subsides.

Iraq is still fraught with chaos, as newly elected leaders wrangle over power and struggle to form a governing coalition. In two months, US troops will prepare to draw down to 50,000 by the end of August, from about 90,000 now — another big window of uncertainty. But civilian deaths are at their lowest levels since the beginning of the war, down from some 3,500 per month to a few hundred. Since December, three US soldiers have died because of hostilities in Iraq, down from more than 100 monthly at the height of the war. Half as many Iraqis applied for refugee status last year as the year before.

But of all the signs of hope for Iraq, some see the value of government-issued bonds as the best predictor of long-term stability. Violence flares periodically, but the price of a bond is based on educated guesses about what the country will look like decades into the future, founded not on politics or ideology, but on a businessman’s bottom line.

“The only thing the bond market cares about is whether a functioning Iraqi government will be there in the future to make the promised interest payments,’’ said Michael Greenstone, an MIT economist. Bond traders take bombings, oil production, and myriad other factors into account when they decide what these bonds are worth, making their price the best aggregate of all that data, he said.

In 2007, Greenstone tracked the value of Iraqi bonds to determine the success of the US military surge, and concluded at the time that Iraq’s prospects still looked murky. But last week, he analyzed the data again — comparing Iraqi bonds with similar bonds from other developing countries. He found a striking change.

“The market’s assessment is that the prospects for a functioning Iraqi state in the future have improved dramatically,’’ he said.

It takes great patience — and not a little chutzpah — to squeeze a profit out of Iraq’s debt, which mounted in the 1980s during a devastating war with Iran. Hussein borrowed an estimated $130 billion, then he invaded Kuwait in 1990.

Iraq got slapped with war reparations and UN sanctions. As debt piled up, Iraq defaulted. But after the 2003 US-led invasion, the Bush administration sent former secretary of state James Baker III around the world, arranging deals that forgave 80 percent of what Iraq owed. To clear the remainder, some creditors were given new bonds in 2006 that pay out 5.8 percent interest annually, and larger amounts as they mature in 2028.

But Iraq’s future was so tenuous then that most investors didn’t think the bonds were worth much. It was unclear what kind of government would take shape in Iraq, let alone whether it would be stable enough to keep its promises to creditors.

In other words, it was the kind of environment that Smith and his partner, Saleh Daher, thrive in. They reap great profit — and take great risks — going “where the Wall Street boys don’t want to be,’’ Smith said, although he declines to provide specifics of their financial performance. Their company, Turan Corp., operates out of a modest office on Federal Street, overshadowed by the financial behemoths of Boston. But in the world of emerging markets, they are legendary.

In 2004, before Iraq even issued its new bonds, Smith and Daher traveled to Baghdad to figure out how to buy them. The country was in ruins. Kidnapping was rife. More than 140 suicide attacks struck that year.

“We stayed at a hotel that had the virtue of already having been bombed,’’ Smith recalled.

Smith, a Brookline native who graduated from Roxbury Latin, Bowdoin College, and Boston University Law School, became a USAID loan officer in Vietnam in the late 1960s to see the world. After stints in El Salvador and Brazil, he returned to Boston to work at his father’s law firm, which specialized in debt collection.

When Smith was hired to go to Turkey to collect a debt, he realized that he could make money buying up Third World government bonds — sometimes called “jungle bonds’’ — for pennies on the dollar. Smith would hold them until the countries could pay or until another buyer came along.

Smith, who enjoys the moniker “the King of the Jungle Bond,’’ hunted for business where capital markets had not yet taken root — Nigeria, Honduras, Russia — pioneering what is now a trillion-dollar industry.

Although Iraq was in turmoil, Smith and Daher thought it was a good long-term bet because geologists estimate Iraq has enough untapped oil to one day rival Saudi Arabia as the world’s largest exporter. On top of that, Baker was all but erasing Iraq’s debt, and Smith didn’t believe that the US government would let Baghdad default on what was left.

From 2006 to mid-2007, as beheadings and attacks mounted, the value of the bonds dropped from $73 to $56 on a $100 bond. But after the surge of extra troops ordered by President Bush began to slow the pace of killings, the price shot back up to $74.

At the end of 2008, the world financial meltdown sent the bonds into a nosedive — to $40 — after investors panicked or were forced to unload the bonds to raise quick cash. Luckily, Smith and Daher had a client who wanted to move the money elsewhere, so they sold the bonds just before the crash. They bought them back again as the bonds began climbing steadily through 2009 as the world economy — and Iraq itself — stabilized.

The bonds hit their highest value ever — nearly $84 — in January 2010, the same month that civilian casualties hit an all-time low, according to Pentagon officials.

Michael O’Hanlon, who tracks indicators of progress for the Brookings Institution’s Iraq Index, said that “Iraq has continued its remarkable trajectory of improvement.’’

“It is still fairly violent by Mideast standards, but many countries in places like South America have higher overall levels of violence now from crime,’’ he said.

Traditional Wall Street investors have taken note. Iraq is now considered a safer bet than Argentina, Venezuela, Pakistan, and Dubai — and is nearly on par with the State of California, according to Bloomberg statistics on credit default swaps, which are considered a raw indicator of default risk.

“Compared to California, I’d rather bet on Iraq,’’ Daher said. “Iraq is a country where there are still bombs going off and people getting murdered, but they are less indebted than the United States. California is likely to have more demands on its resources, and there is no miracle where California is going to have more revenue coming out of the sky. Iraq has prospects for tremendously higher revenues, if they can manage to get their act halfway together, which they seem to be doing.’’

Smith and Daher are keeping their Iraqi bonds, but they aren’t buying any new ones. Now that other investors have returned to Iraq, prices are high, so Smith is looking elsewhere. Perhaps that is one of the strongest signals yet that normal life is returning to Iraq: Bob Smith is getting out.”

This entry was posted on Monday, March 22nd, 2010 at 11:19 am and is filed under Iraq.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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