The 1MDB Scandal And The Nature of Debt

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My co-host, Joe Weisenthal, is away this week. I believe he is sampling the electric scooter scene over in Los Angeles, but this actually gives me an opportunity to dig into a slightly geekier subject, and that would be sovereign debt restructurings. This is when governments opt to exchange their loans or bonds for new loans or bonds, you know, typically less expensive ones, or when they decide to pay back their debt at a slower pace or a cheaper pace or whatever. All of this hashed out amongst lawyers, typically acting on behalf of the borrower, the country that borrowed the money, and the lenders, the investors that lent it. And yes, I can sense your excitement from here.

But before you turn this podcast off, we are actually going to be marrying one of the biggest stories in finance and markets right now with the theme of sovereign debt restructurings. And that story is 1MDB, the 1MDB scandal that is currently rocking Asia and has certainly extended beyond the region all the way over to Goldman Sachs in New York. And the interesting thing about 1MDB is that it involves government guaranteed debt in addition to super yachts and Leonardo DiCaprio.

And it can actually be, I think, a jumping off point to discuss the fundamental heart of sovereign debt, which is a government guarantee or a promise that the borrower, the state, is going to repay the money that it's borrowed. So here with us to discuss this, and I'm very excited about it, is Mithu Gulati. He's a professor of law at Duke University, and he also blogs over at CreditSlips, which I urge you all to read. So Mithu, thank you so much for coming on.

Mithu Gulati (2:03)

Thank you, Tracy. It's a delight to be talking to you after such a long time.

Tracy Alloway (2:08)

It has been a long time. So I'm going to outsource some of my hosting abilities since Joe is away, and I'm going to ask you to set the scene for us.

What is the 1MDB scandal, and how does it feed into your particular area of expertise?

Mithu Gulati (2:25)

So the 1MDB scandal, and I'm going to draw here heavily from articles in Bloomberg and the Wall Street Journal and the Financial Times. I did not come to the 1MDB scandal right at the start. I came to it like many others did because of writing in the press and this wonderful book that two Wall Street Journal reporters did. But one bit about the 1MDB scandal caught my attention, and that was that this finance vehicle, essentially a sovereign wealth fund for Malaysia, that didn't do the normal stuff that sovereign wealth funds did, which was to invest the money of the country. Instead, it was borrowing money. Sort of the opposite of what you would normally do with a sovereign wealth fund. It was a sovereign wealth fund that had no wealth of the sovereign.

It was accumulating wealth by borrowing from outside investors and then siphoning it off to these corrupt financiers who were running it.

And what interested me about that was, not only were they corrupt, but they had managed in a couple of the bonds to get the state of Malaysia to actually guarantee the payments to the outside investors.

And so, it sort of merged this corruption angle with sovereign financing because it was basically corruption in the raising of the money and then sticking the bill to the taxpayers. Now, it got even more interesting sort of at the end of the story after the scandal is revealed and then the Malaysian government falls, which is fairly stunning in corruption scandals in South Asia. Usually, for those of us who live in South Asia, we're used to this kind of corruption scandal, but this was just bigger than even what we're used to. And the government falls and the new government comes in, and there were a couple of these 1MDB financings that did not have a state guarantee. And the new government comes in, and one of the first things that the finance minister does is to slap a new guarantee on these corrupt debts, which to me was completely bizarre. So years ago, my friend Lee Bukhait and I worked on corrupt loans in Iraq. And in our research, one of the things that we discovered was the one way for countries to get out of debt obligations in a restructuring or just in a court proceeding is to have evidence of corruption. If there's evidence of corruption by, especially by the agents of the bank, then you can go to court and say, this is not really our loan, stick this to the bank that was corrupt and engineered the loan. Malaysia had this evidence in spades. I mean, the reporters had done a fantastic job of uncovering all this evidence. So Malaysia could have said, we're not gonna pay this. Instead, they did the opposite, which is to embrace the loan and say, even though it was corrupt, we're gonna stick our taxpayers with it. And these are poor taxpayers, a poor country, and it dramatically increases their debt stock. And so there are all sorts of bad things that happen.