Franklin Templeton bond manager Michael Hasenstab wants Kiev to pay back money it doesn’t have. If he stands firm, Ukraine’s fragile economy could implode.
- By David FrancisDavid Francis is a senior reporter for Foreign Policy, where he covers international finance. An award-winning journalist, David has reported from all over Europe, Nigeria, Kenya, Mexico, and Afghanistan on terrorism, national security, the geopolitics of energy, global economics, and the European financial crisis. His work has been published in outlets including the Christian Science Monitor, the Financial Times Deutschland, Slate, and SportsIllustrated.com.
In recent months, Ukrainian government officials have been crisscrossing the globe, asking its creditors for relief on $23 billion in debt the country says it can’t pay. Without it, Kiev’s economy could sink into the financial void. That puts Michael Hasenstab, the boy wonder of distressed debt management, front-and-center in a financial crisis that could determine the fate of a country Russian President Vladimir Putin covets with eager eyes.
Hasenstab, 42, represents Franklin Templeton as one of the four members on the Ad-hoc Committee of Bondholders to the Ukraine, a panel of representatives from three U.S. mutual funds and one Brazilian bank. The debt holders have to decide whether they will acquiesce to Ukraine’s demands and allow it to pay 40 percent less than it owes. As the largest holders of Kiev’s debt, Hasenstab stands to lose billions if that occurs.
Ukraine is in desperate need of economic growth, something it’s been severely lacking in recent years. Investors have been spooked away by the continuing civil war with Russian-backed separatists in its east, as well as years as endemic government corruption.
Ukrainian officials are promising reforms, but they won’t come soon enough to attract the new investment necessary for broad economic growth. They’re also squabbling with the European Union and the International Monetary Fund over broader questions over what types of painful austerity measures to accept in exchange for a financial lifeline. In order to access a $17.5 billion bailout from the IMF — money Kiev desperately needs to stay solvent — Ukraine and its creditors have to agree on how, and how much, Ukrainian Prime Minister Arseniy Yatsenyuk’s government would pay back on the bond payments over the next three years. It’s clear Kiev doesn’t have the money to pony up what it currently owes; as of the end of 2014, it only had $7.5 billion in reserves, the lowest level since 2004.
That puts Hasenstaub in a powerful position. He could mimic Paul Singer, the hedge fund maven at Elliott Management, who refused to take a so-called “haircut” — a creditor agreeing to allow a borrower to pay back less than what they borrowed — on more than $100 billion in Argentine debt in 2001. Argentina ultimately suffered the largest sovereign debt default ever, sending its economy into the worst recession in the country’s history, leading to unemployment of more than 20 percent, a GDP drop of 11 percent, and riots on Argentine streets that left 27 dead and more than 150 injured. Argentina’s president at the time, Fernando De la Rua, had to declare a “state of siege.” He was forced to resign, and had to escape Casa Rosada, Argentina’s executive residence, in a helicopter as his country’s economy collapsed. To this day, Singer continues to fight for what he’s owed in American courts and through less traditional methods; in 2012, he convinced a court in Ghana to seize an Argentine naval vessel, La Fragata Libertad, as partial repayment for some of the country’s debt.
Sources familiar with Elliott’s thinking tell FP that the fund has offered both publicly and privately to negotiate any aspect of the dispute, including accepting a haircut and taking bonds instead of cash as part of any settlement, but Argentina has consistently refused to negotiate.
Most recently, according to a New York Times from January, Singer rejected repayment offers of around 30 cents on the dollar on his Argentine debt investment.
The kind of economic and social chaos Argentina experienced could erupt inside Ukraine if it defaults, putting Hasenstab — who declined, though a spokesperson, to comment — in a difficult spot. If he gives into Kiev’s demands, he’ll take a steep loss on his $6.5 billion investment there. He’s already taken a loss of $3 billion. Yet he’s refused to budge on the haircut. If he doesn’t, he might never get paid, just like Singer, and Ukraine’s economy would sink into even deeper despair. Months of talks have gone between Hasenstab and his Ukrainian debtors have gone nowhere. A meeting in March of this year ended with tense verbal back-and-forths between the two sides, including Ukrainian Finance Minister Natalie Jaresko hint that the terms of the deal would only get worse if talks dragged on. A new round of negotiations began last month.
Franklin Templeton spokesperson Stacey Coleman referred FP to two recent letters-to-editors sent by Hasenstab on behalf of the Ad-hoc Committee of Bondholders to the Ukraine that make clear Hasenstab has, so far, ruled out debt relief. He insists Ukraine’s financial troubles lie with short-term liquidity, not Kiev’s inability to pay back what it owes over the long term.
In one, sent to the Financial Times on June 17, Hasenstab wrote, “Along with the International Monetary Fund, the committee’s members have been long-term supporters of Ukraine, investing under successive governments, delivering capital to put in place vital infrastructure. We would like that to continue under the current president, who has been so successful at implementing reform. However, the committee believes taking a haircut on bonds is not the right way to achieve that.”
“A haircut sends the wrong signal to global capital markets when Ukraine can least afford to be shunned,” he added.
In the second, sent to the Washington Post on July 12, he wrote, that the “Ad-hoc Committee of Bondholders to the Ukraine has invested in the country for more than 10 years, under successive governments, to help fund essential public services and infrastructure, and we well understand its challenges.”
“We believe Ukraine’s financial troubles can be resolved for all parties without creditors immediately writing down the value of their bonds,” Hassenstab wrote.
Hasenstab is taking what, from his perspective and that of many finance professionals, is a reasonable position. He wants the money Ukraine promised to pay back. And he’s given countries like Ireland, Poland, and Hungary, all close to financial ruin, a much-needed financial shot-in-the-arm that helped stabilize their economies.
“He’s a brilliant guy,” said Alex Petrovic, a financial planner in Kansas City, Mo., who has his client’s money in Franklin Templeton funds. “He has a long history of making good bets, and this long history is excellent. We have confidence in him. ”
Ukraine insists Hasenstab and its other creditors have to recognize Kiev is not in a position to pay its debts.
In a recent interview with Foreign Policy, Jaresko, a financier born in suburban Chicago, said Kiev’s negotiators are making progress with “some of the creditors.”
The unresolved debt issue “holds up the certainty of our financial and economic health,” Jaresko said. “We’re trying to focus not on the destabilization that this enabled, but real growth. It’s a lynchpin of our financial health.”
It’s a hard sell for one simple reason: Ukraine is quickly becoming associated with two words that have consistently spooked markets for the last five years — especially this summer — and sent investors running: distressed debt, or loans a country can’t pay back.
Hasenstab, based in San Mateo, California, manages Franklin Templeton’s Global Bond Fund and Global Total Return Fund, and he’s been a so-called “vulture” investor — someone who buys up distressed assets, hoping to sell them for a big profit down the line — for years. These funds are where he made big bets on Ukraine’s ability to pay its debt. He’s the largest holder of Kiev’s bonds, with about $6.5 billion under management; in 2012, his position was $8 billion. And he’s already paid dearly for his gamble. Right now, those assets are worth only $4 billion.
It’s a short-term loss for a money manager who likes to play the long game. But the Kiev gambit has investors spooked. Last year, a record $14 billion flooded out Hasenstab’s two funds. According to Morningstar, an additional $2.5 billion left in the first four months of 2015.
A comparison with the Greek financial crisis is inevitable, because the Hellenic nation is also seeking a haircut from its creditors, the IMF, the European Central Bank, and the European Commission. Kiev wants relief from a total debt load of $23 billion between 2015 and 2018 — a paltry amount when compared to Greece. According to Reuters, as of June 30, Athens is in hock to the tune of some 243 billion euros, or $265 billion.
But the stakes of the Ukraine debt standoff are arguably just as high as those in Greece. Ukraine wants a group of four creditors, holding about $9 billion in its distressed assets, to accept the 40 percent haircut, a move that would reduce its debt load to $15.3 billion. In June, the creditors’ committee rejected the proposal. Negotiations are currently ongoing, and without the IMF bailout, Ukraine is likely to go broke. The last thing the United States wants is a failed economic state that has areas Putin claims to be part of Russia.
If Hasenstab is forced to take a loss, he’ll be in unfamiliar territory. According to Bloomberg data, his Global Bond Fund has averaged annual gains of 10.1 percent for the last decade.
But his bet on Ukraine could end the streak. As of June 30, the Global Bond Fund is down 1.93 percent. Last year, it also was down nearly 2 percent, ranking Hasenstab 54th among other global debt managers, Bloomberg data shows.
Petrovic compared Hasenstab to a star baseball pitcher taking the mound on the opening day of a new season. His past performance hints he’ll perform well, “but you can’t be sure what the results are going to be,” Petrovic told FP.
Hasenstab took an unconventional path to the top of the Wall Street food chain. He grew up in Olympia, Washington, and went to Carleton College, a small, academically rigorous, liberal arts school in Minnesota. From there, he went to the Australian National University, where he received a masters in economics. He then chose to get a Ph.D. in philosophy from the Asia Pacific School of Economics and Management, shunning more traditional economics powerhouses like Harvard or the University of Chicago. In 2001, he took a year off to complete the philosophy doctorate, a curious choice for rising a master of the financial universe. According to his biography on the Franklin Templeton website, he climbed to the summit of Mount Everest in 2013. A Barron’s profile said he also trekked up Mount Kilimanjaro on his honeymoon with his wife, Mary Ann.
He also lacks the conceit his wealth could afford him. A 2011 article in Citywire Global, a magazine focused on bonds, said Hasenstab “does self-effacing charm like nobody’s business but at times you almost will him to be a bit of a diva, more cut-throat, or for a man with such huge assets at his disposal, at least have a hint of arrogance about him.” The same piece compared him to money management legend Bill Gross, who founded Pacific Investment Management and ran its $270 billion Total Return Fund, once the world’s largest. Gross left for Janus Capital Group in 2014.
A 2014 Wall Street Journal profile describes Hasenstab as a “monk” who often spends years before deciding to invest. He spends two-thirds of the year on the ground in countries he’s considering investing in. To beat jet lag, he jogs.
His money management style is also unconventional. Bond fund managers traditionally like to play it safe; returns on investments in debt pale in comparison to what can be made in the current six year bull market. Hasenstab does the opposite of most of his peers: he makes his name by placing risky bets that countries close to financial ruin would return to growth, and that emerging markets would actually emerge. In 2010, when investors were running from Europe’s sovereign debt crisis, he snatched up Irish government bonds at a low price after the bloated housing market there imploded. Hasenstab, who has been with Franklin Templeton since 1995, made a handsome profit when the European Central Bank bailed out Dublin. The Irish economy has now stabilized, something Hasenstab predicted would happen in a 2011 Wall Street Journal op-ed.
He did the same thing in Hungary, buying up its bonds on the cheap. He then watched his profits soar when Hungary’s dollar bond funds averaged a 54 percent return over the past three years. Hasenstab also made bets on debt in South Korea, Poland, and Uruguay.
Hasenstab’s strategy is celebrated by the financial press. In June, Forbes called him one of their “new money masters.” In 2014, the Economist called him the financial manager who invests “where others fear to tread.” He was named the top global bond fund manager by Bloomberg Markets magazine in 2010. That same year, Barron’s called him a “new world explorer.”
Complicating the debt talks is Russia. Kiev owes Moscow a $3 billion bond payment, due in December. In January 2015, Russia’s state-run RIA news service reported Finance Minister Anton Siluanov could call for an early payment because Kiev’s debt-to-GDP ratio exceeded 60 percent of Ukraine’s gross domestic product.
Hasenstab has been bullish on Ukraine, despite Putin’s meddling there. In an April 9, 2014, research note, published just weeks after Putin annexed Crimea, Hasenstab cited Ukraine’s debt-to-GDP ratio at the time — just over 40 percent — as one of the reasons he believed it would become a success.
“We think the current government has done an exceptional job, not just of tackling the short-term issues but also setting the stage for Ukraine to potentially flourish over the next five to 10 years, putting in place very difficult but very important structural reforms,” Hasenstab wrote in the research note.
In an interview with Foreign Policy, U.S. Commerce Secretary Penny Pritzker cited these reforms as reasons for U.S. companies to ignore the debt uncertainty and invest in Ukraine. She said fighting with forces backed by Putin is limited to a small portion of the country, and disputed the broad perception that Ukraine is mired in chaos.
“Allowing Ukraine the opportunity to reengage with the investment community is an important part of what the United States can do to help a country going through an extremely challenging and complex transition,” Pritzker said.
For years, corruption has been endemic in Ukraine. Transparency International’s Corruption Perceptions Index, the most trusted indicator of global graft, ranks Ukraine 142nd in the world, six spots below Russia. Politicians and businessmen have plundered state budgets: according to Reuters, from 2010 to 2014, one-fifth of the country’s national output was lost to illegal dealings.
“It’s profoundly in the self-interest of the United States to see Ukraine emerge as prosperous, democratic, independent, and reform-oriented,” Vice President Joe Biden said at a July 13 Chamber of Commerce event to urge American businesses to invest in Kiev’s economy. “Ukraine has a strategy and new laws to fight corruption. Now you’ve got to put people in jail.”
Ukraine’s public is all too aware of its government’s shady dealings. In 2004, street protests helped the pro-Europe former Ukrainian President Viktor Yushchenko push back an attempt by then-Prime Minister Viktor Yanukovych, who is unabashedly pro-Russia, to rig an election. Yanukovych claimed he was poisoned in the run up to the vote, and suspicion soon fell on Russia. On February 21, 2014, demonstrations on the streets of Kiev forced Yanukovych, who won the presidency in 2010, into Moscow’s arms. Less than a week later, Russian troops were in Crimea.
These protests have done little to affect economic change. Ukraine is now warning its economy will shrink for a second year in a row, making the prospect that officials could come up with the cash all the less likely. Ukraine’s economy shrank 7.5 percent in 2014; Ukrainian officials expect it to contract an additional 5.5 percent this year.
But the World Bank’s forecast is more dire. It said in April that Ukraine’s economy would shrink by 7.5 percent by the start of 2016.
Goldman Sachs also predicts its debt to GDP ratio will approach 100 percent this year. Since the Crimea annexation, the value of its currency, the hryvnia, has plummeted. Before Russian moved on Crimea eight units of Ukraine’s currency, the hryvnia, was worth $1. Now, 22 are.
There are also growing concerns Ukrainian politicians are watering down a reform package the IMF says is needed for any bailout. In the runup to the July Chamber of Commerce meeting, Ukrainian President Petro Poroshenko promised to veto a foreign exchange loan bill if parliament failed to repeal it.
“I will defend Ukraine,” Poroshenko told Ukrainian television July 12.
Poul Thomsen, the IMF’s European department director, responded in a statement that same day. The IMF has already given Ukraine $5 billion, but is holding back on handing over the rest of the $17.5 billion bailout.
“Reversing economic reforms for the sake of short-term gains has been detrimental to Ukraine’s economy in the past,” Thomsen said. “Ukraine needs to stay the course on reforms.”
Jaresko said this time, things will be different.
“We’re walking the walk. Everything we’re saying, we’re doing,” she said. “We want to continue to see more and more on anti-corruption. We’re looking for follow through.”
“That is our goal, to do what we promised,” Jaresko added.
Clarification, July 29, 2015: Franklin Templeton and the other members of the Ad-hoc Committee of Bondholders have invested in Ukraine for more than 10 years, though they refuse to say how the size of those holdings compares to the ones made since the country entered a period of prolonged political and economic instability in 2011.