When your word is your bond

03-09-2016

The new Czechoslovak state created from the debris of WWI understood one thing from the outset, that a fundamental factor in the prosperity and success of the new state would be winning the confidence of international investors in the country and its currency.

Tough and unpopular budget discipline was enforced to build trust in the new currency and the eventual international vote of confidence in the country was the successful launch of its first bond issue.

Bonds are essentially a state’s IOU, promising to payback the original amount loaned along with regular interest payments in between over long periods. They are a stable, if unspectacular, investment tool. But the flip side though is the scenario if a state says it will not pay up on its bond; so-called default is a spectacular signal which creates fear across the international capital markets.

That though was precisely what the Communist regime did on a swathe of bonds, including the prestigious 1922 Czechoslovak state issue, after coming to power in 1948. Later it sought to make amends be negotiating deals with some of the countries whose citizens were hurt most by the default. Once again, the Communist regime was charged with shortchanging the bondholders, a state of play which some argue remains the case till today.

One, of those is Prague-based fund manager Jeremy Monk. And he believes that some detective work carried out in the United States about the final agreement between the Czechoslovak authorities, the US and an organization representing bond holders should increase pressure on the current Czech government to prove that its word is its bond.

Mr. Monk takes up the story by describing the swathe of bonds which the Czechoslovak state, cities and companies issued to provide the foundation for its economic success:

“We are talking about foreign denominated bonds issued in the early 1920’s. The most significant was the Czechoslovak state bond of 1922. That was closely followed by some municipal bonds, the City of Greater Prague and then in 1924 we also had a bond issued by Karlovy Vary. That was then followed by corporate issues including First Bohemia Glass. One or two others have come to light, possibly Brunner Turbine would be another example of a foreign denominated bond issued from the Czechoslovak Republic.”

“It was a hugely historically important bond issue because it was the first international bond issue not only from the Czechoslovak state but from any Central European country.”

The state bond was the key. Its success meant essentially that Czechoslovakia had won the argument where it mattered that the country was a good and stable bet way into the future. Mr. Monk again:

”It was a hugely historically important bond issue because it was the first international bond issue not only from the Czechoslovak state but from any Central European country. If was really formal recognition of the Czechoslovak state as an independent entity by the great powers. The great powers, of course, then being Great Britain, France, and America [the United States]. So it was international recognition. It was also hugely historically important in terms of the economic success of the Czech Republic as well because it immediately stabilized the economic situation, immediately led to a stabilization in the value of the currency. It enabled all these follow up bond issues as well. So, in fact, in the inter-war years whereas many neighbouring countries such as Germany were really suffering, it was the golden era for Czechoslovakia.”

The state bond issues, denominated in both US dollars and the United Kingdom’s sterling, was shared out between some of the biggest financial centres of the day and won substantial interest from an international and domestic audience.

“The bond issues took place basically in New York, London, and some bonds were also directly sold into Amsterdam. Obviously, there was some domestic demand for these bonds as well. In terms of the dollar bond issues we are talking about 36 million dollars but of course it was gold dollars as they were then so the value now is very high.”

Jeremy Monk, photo: archive of Jeremy MonkJeremy Monk, photo: archive of Jeremy Monk As economic tension mounted in the 1930s, bondholders in Czechoslovakia were invited to switch their dollar and sterling denominated bonds into ones in crowns. It was a fairly orthodox way of allowing the state and Czechoslovak central bank of reducing its future exposure to pressure on the local currency. But foreign bond holders were not covered by the move. Other, still run of the mill, moves followed WWII but the big shock, default, come after the Communist seizure of power.

“Just before the Communist takeover, in 1946 the maturities of all these bonds were all extended and the coupons, the interest rates, were reduced. That’s quite common to happen to bonds after a difficult period, which obviously WWII was a difficult period. However, then in 1952, after the Communist putsch in 1948, the dollar bonds were defaulted on. In 1959, the Sterling bonds were defaulted on.”

The Communists eventually sought to patch up relations following their move which effectively made them pariahs on the international capital markets. A deal with London came quickly but that with the US was a much more drawn out affair.

“Well the Sterling bond holders, just to briefly cover that side of the story, were somewhat luckier because immediately after the Sterling default in 1959, the British government intervened and in fact a settlement was reached quite quickly in 1960 whereby Sterling bond holders got back 75 percent of the face value of what they were owed. Unfortunately, the story with regard to the dollar bond holders was less fortunate. In fact, negotiations there dragged on for decades. Eventually a broad settlement was reached in 1982 involving the return of 18.5 tons of gold which the Allies had seized at the end of WWII. That gold was returned to the Czechoslovak state in return for about 81 million dollars of payments to be made to those who had lost property following the Communist takeover. Unfortunately, the bond holders did not actually receive a payment at that time. Instead, in the annex to that agreement there was a commitment that a settlement would be reached with the bond holders. Nevertheless, the gold was returned prior to any settlement with them and that later caused problems.”

“The story with regard to the dollar bond holders was less fortunate. In fact, negotiations there dragged on for decades.“

Monk says his research show that the Communists played hardball once they got the gold back in their hands. They did everything to exclude many categories of bond holders from making claims for payments against them and appeared determined that the costs would be as low as possible. The US government appeared to do little to salvage a deal which appeared fatally flawed once the gold was gone. Jeremy Monk continues:

“It was widely condemned. It was even condemned by the Foreign Bond Holders Protective Council, who were the appointed agents to represent the bond holders. They condemned the matter, obviously the bond holders did. And pretty quickly their warnings proved absolutely correct because when negotiations started, the Czechoslovak side were pretty intransigent and in fact what happened as a result is that you had a highly discriminatory agreement. Certain bonds were completely excluded, for example bonds of First Bohemia Glass, which was a nationalised company, they were completely out of the story. Then, émigrés, bonds that the Czechoslovak state said were held by émigrés, they did not get a payment. Other bond holders who were holding bonds subject to a New York court case that went against the Czechoslovak state, those bonds only got 20 percent, a much lower payout. And to cap it all, there seems to be evidence that the settlement in its entirety was underfunded. So, you have many bonds still in issue, stamped as consenting and accepting the offer and did not get payment. So it was pretty much was a farce in the end.”

Mr. Monk is not the first to have been frustrated by the Czech finance ministry’s alleged stonewalling on the issue of these non-honoured bonds. But he has been able to consult the agreements promising eventual payment and track the Communist moves to whittle down the claims they would face by going to the archives of the US body that was supposed to represent the bond holders.

“It is also an opportunity because we are now coming up to the centenary of the foundation of the Czechoslovak Republic.”

“I was really quite frustrated because I knew about the story from five years ago when Edward Fagan hit the headlines with some of these bonds. I was curious about the agreement that these bonds were subject to because, of course, there should have been a settlement. These bonds should not still be in issue. Then, I came across some of these bonds myself, bonds that were stamped as consenting to the offer, wrote to the Ministry of Finance and pretty much received very evasive answers. I requested many times a copy of the agreement that these bonds were meant to have consented to, it wasn’t forthcoming. So I was really frustrated. They [the ministry] refused even to authenticate the bonds, which is surprising since I have had experience of the US Treasury authenticating pre-war bonds. It was a completely different experience I should say. So I was frustrated, but also felt helpless, where on earth was I going to get the real story from. Then I happened to notice that the archives of the Foreign Bond Holders Protective Council, which were the American representatives to the agreement, were actually at Stanford University Libraries. They were kind enough to send me copies of the signed agreements. I still wanted to look through the archives and by chance a good friend of mine happened to be presenting at Stanford and agreed to look through the archives. The article I wrote was really based on archive evidence.”

Monk believes that the new evidence out now in public and the rapidly looming anniversary of the foundation of the Czechoslovak state could increase the pressure on the Czech finance ministry to honour its old debts. He says the Czech state, and its predecessor Czechoslovakia, are unique in apparently holding out against honouring an agreement and payments that should have been made. And he has suggested that US authorities might like to contribute as well since they were so laid back in protecting their bond holders’ interests 30 years ago. Mr. Monk adds that he has very little personally to gain from any final payment:

“We are not talking about a great deal of money.”

“The whole story really intrigued me. When an institution gets evasive you clearly want to get to the truth. That was the motivation finding out what really happened. I think now that the facts are in the public domain backed by the archive evidence, it is very difficult now for the Czech authorities to claim that they do not know what really happened. If they don’t know they are welcome to read through the archives, read my article themselves. What is absolutely clear is that all these bond issues were really negotiated at the absolute highest level of the Czechoslovak state. You had the prime minister personally negotiating, Edvard Beneš, the president’s son, Jan Masaryk, also heavily involved in the negotiations. So the fact that these bonds remain outstanding is in some ways a disgrace – they should have received full payment and been included in any settlement. However, it is also an opportunity because we are now coming up to the centenary of the foundation of the Czechoslovak Republic. It’s a time for reflection on the values that the current republic is founded on. Those values that are very much embraced in the First Republic of honest dealing and your word is your bond, those things should really carry through to the current time. I thank many Czechs appreciate that. And for that reason, maybe that reason alone, I think the government will come round to the conclusion that it would be appropriate to settle these claims.”

Monk says the cost of Prague agreeing to fulfill its promises and make the payments on the bonds would be fairly low price to pay for its honour.

“In terms of the theoretical number outstanding, I put it at about US 1.9 million dollars as the face value. Obviously many of those will have been lost over the intervening period. I have made a few assumptions of what I think an appropriate settlement would be. I have assumed that all those present in the 1986 settlement that did not receive compensation would again be presented. I have also assumed that those that weren’t presented at that time, about 25 percent of the outstanding bonds, would be presented. So, putting all that together I have assumed that around half a million dollars worth of bonds would be presented at historic face value. However, remember that this settlement took place 30 years ago. If you apply some penalty interest because of the late payment, if you apply 15 percent interest, then you get a figure of 36 million dollars. If you apply a lower rate, say 10 percent per annum, you get a much lower figure of around 10 million dollars. So we are not talking about a great deal of money.“

The Czech finance ministry has said in the past that the time limit for claims to be made on these bonds has long since expired.

03-09-2016