THE activities of our bankers in sponsoring the sale of foreign securities in the American market is now under investigation. This is not surprising when we consider that out of a total of approximately eight billion dollars of foreign loans floated here during the past ten years, almost one billion are either in default or will shortly be in default as a result of the moratorium legislation which has been adopted by various foreign debtor countries. In addition, many other foreign issues are selling at a fraction of the price at which they were originally marketed. The American investor is a newcomer in the field of foreign financing and his first and possibly natural reaction is to place the blame for this situation upon the bankers who have sold the securities. Granted that there was over-lending during the past few years, and that other mistakes have been made, we nevertheless are perhaps inclined to exaggerate the bankers' share of responsibility. The foreign loans sponsored by the most experienced of the European bankers have suffered in much the same way as our own and they have been partners with our bankers in many of the foreign issues which originated in the United States. It is true that we have recently been the largest lenders to foreign countries, but this is largely accounted for by our possession of available capital seeking employment rather than by any fundamental difference in policy between the European and the American houses of issue.

Where there have been widespread defaults on foreign issues the direct cause, both in the past and at the present time, can be traced to a world-wide depression. For example, it is calculated that the North and South American securities listed on the London Stock Exchange depreciated over $500,000,000 during the five years preceding 1895, and the British investor had a somewhat corresponding loss in the years following the depression of 1873. These depressions were no more predictable than the present one; the consequences to the investor were much the same, and it is hardly fair to saddle the bankers with sole responsibility for failing to forecast and provide against such conditions.

Even though the European bankers may not have been much more astute in the selection of foreign investments than our own bankers, their long experience in dealing with foreign financing has enabled them to develop a special technique in the handling of defaults on foreign issues. We should not overlook the lessons of their experience. It is clearly desirable to investigate the mistakes of the past in order to prevent a repetition of them, so far as they are avoidable; but it would be unfortunate if at the same time we did not make a careful study of the most effective means of curing existing defaults on foreign issues, or at least of salvaging for the American holder of foreign securities the maximum that can be obtained.

When domestic issues go into default there is a time-honored method of procedure for the bondholder to follow. A protective committee is formed, generally on the initiative of the bankers who sponsored the loan, bonds are deposited with the committee, and the debtor (unless a municipality or other public body is involved) is forced to reorganize his business and adjust his capital structure, or his assets are liquidated and distributed to the bondholders. If a domestic municipal obligation is involved, the procedure may be somewhat more cumbersome and less under the control of the bondholders; but generally remedies are available and there is a reasonably clear course to follow.

Cases of default under a foreign bond issue, where a foreign government, state or municipal obligation is involved, present a very different type of problem. And it is this type of default which is involved in most of the foreign dollar issues on which payment has recently been suspended. Here there is no effective remedy at law. Even where the general laws of a foreign country permit suit to be brought, and this is rarely the case, legal action would be futile. In most cases specific moratorium legislation, or legislation preventing the transfer from domestic to foreign currency, makes any effective recovery at the present time impossible. The only course for the bondholder in such cases is through negotiation with the debtor. It is obvious that such negotiations cannot be carried on by the individual bondholders. Any hope of success depends upon concerted action through some agency which has authority to speak for, and to conclude arrangements on behalf of, the bondholders. The initiative for such concerted action can hardly be left to the widely scattered holders of this or that particular issue.

Before considering the particular problems presented by the default on foreign issues recently floated in the United States, we may find it helpful to review the precedents which have been set by England, France and certain other European countries.

The Corporation of Foreign Bondholders was founded in England in 1868 and was reconstituted in 1898 under Act of Parliament. The Council of the Corporation consists of twenty-one members, of whom six are nominated by the British Bankers Association and six by the London Chamber of Commerce, with nine members nominated by the other twelve. The British Bankers Association is composed of representatives of the commercial banks, rather than of the houses of issue. The original funds of the Corporation were obtained through the subscription of £100 each by 1,000 individual holders of defaulted foreign state securities. This fund has been increased from time to time from various sources; and at the present time the invested funds of the Corporation amount to about £200,000. The objects and scope of the British Corporation as summarized from its Charter are:

To watch over and protect the rights and interests of the holders of foreign securities; to collect and preserve statistics, reports and data; to adopt measures for the protection, vindication and preservation of the rights of the holders of foreign securities, either on any default or upon breach of any condition under which the securities have been issued; to negotiate, or to assist in negotiating, resumption of payment or settlement, of issues in default; to convene meetings of holders of public securities for the purposes of concerting with them the requisite measures to be adopted on their behalf; to organize and despatch representatives to carry out direct negotiations with the defaulting obligor; to render assistance to, and support measures and enterprises calculated to maintain and promote public credit; and to benefit the holders of foreign securities.

In the event of default on a British issue placed abroad, the British Corporation usually calls a meeting of the interested bondholders, suggests a particular committee to deal with that particular default, and then lends its facilities and services to the committee to help in negotiating a settlement. The issuing bankers are generally represented on this committee. The expenses of the committee are met out of the funds of the Corporation and recovered when a settlement is made, either from the state concerned or by a pro rata charge upon the bondholders concerned. The members of the Council have no interest in this fund, which is administered by the Council of the Corporation on behalf of the general interests which it represents and not for profit. In cases which do not seem to call for the formation of a particular committee, the Council of the Corporation acts directly on its own initiative in defense of the bondholders. In a recent letter descriptive of the Council it was pointed out that the British issuing bankers are thus saved the necessity of choosing between offending a foreign state by strong protest or offending the bondholders by inaction. During the sixty odd years of its existence the Corporation has been concerned in the settlement of debts aggregating approximately $5,000,000,000.

The French Association -- Association Nationale des Porteurs Français de Valeurs Mobilières -- was organized in 1898 by the Paris Stock Exchange at the request of the French Minister of Finance. While authorized by its Charter to protect the holders of domestic as well as of foreign issues, the Association has largely exercised its functions on behalf of the latter. The purpose of the association was to serve as a center of information and as an organization for the defense of the interests of the bondholders. It is administered by a Council composed of nine members -- at present including representatives of the Stock Exchange, of two of the larger commercial banks, a leading professor of law, and a former representative of the Minister of Finance. The Association is financed by the Stock Exchange and by contributions from other subscribers. The activity of the Association is very similar to that of the British Corporation of Foreign Bondholders; that is, the Association takes the initiative in determining whether the formation of a protective committee for a particular issue in default is desirable. Several other European countries have institutions somewhat similar to those existing in England and France, although of course as those two countries have done the bulk of the foreign financing originated in Europe the need for elaborate organizations has not been as keenly felt elsewhere.

In considering the question as to whether there should be an American association of the above type for the protection of the holders of foreign bonds, three questions naturally arise: Is there a real need for it, which is not otherwise met? What should be the character and duties of the association ? How could the association be financed?

Obviously there is no reason to follow blindly the lead of other countries, even though the institutions they have established have proved useful in their cases. The American banking system differs in many respects from the European. Foreign financing in the United States has been in the hands of a large number of banking institutions with diversified and often conflicting interests, and these banking institutions in most instances have indicated a willingness to watch out for the interests of the holders of defaulted bonds which they have sponsored. In England and France the number of issuing houses is relatively restricted and their coöperation with a protective association can be easily arranged. In Europe the governments have guided the policy of the bankers to a degree unknown in this country. These are only a few of the points of difference. We should examine the American situation de novo before deciding whether under conditions as they exist in this country a protective association could fulfil a useful function and whether it is necessary, in view of existing organizations. We already have the Foreign Securities Committee of the Investment Bankers Association, and the Institute of International Finance which is conducted by the Investment Bankers Association in coöperation with New York University. The Institute has performed a very useful work in collecting and disseminating data about the financial situation of various foreign states which have borrowed largely in this market and about the action taken by countries in default to preserve their credit. The Institute may consider enlarging its functions, and take the initiative necessary to bring about the formation of protective committees. It is already committed to opposing the further issue of securities by a country in default when this would be detrimental to the holders of that country's obligations.

Notwithstanding the particular character of our banking system and the existence of the Institute of International Finance, there are reasons which justify giving the fullest consideration to the organization of an American association for the protection of foreign bondholders somewhat along the lines of the British Corporation, provided proper personnel and adequate financial backing can be found.

In many cases the issuing bankers are those logically indicated to take the initiative in protecting the holders of defaulted foreign issues which they have sponsored. Often, however, this is not the case, and there are other occasions where the bankers, although able and possibly willing to take action, are not the best qualified under the circumstances to be of help to the bondholders. There are also situations where the bankers have other interests which make it difficult or embarrassing for them to act. For example, several of the American houses which originated foreign issues have passed out of existence since 1930, or have entirely withdrawn from the type of business which qualifies them to act effectively in the foreign field. There are other cases where the bankers have sponsored the issue of bonds of a certain obligor, and have subsequently purchased and now hold the short-term obligations of the same debtor. When only a limited amount of foreign exchange is available, it obviously places the bankers in an embarrassing and difficult position to make representations as to how that foreign exchange shall be allocated as between the short-term obligations which they hold, and the long-term bonds which they have sold to the public. In some countries the issuing bankers are the fiscal agents for the obligor in default, or have local business interests in the country in default which are dependent upon the cultivation of good relations with that country's authorities. In either case it may be embarrassing for them to take the vigorous action which might be required to enforce the rights of bondholders. In some instances the bankers have negotiated their bond issues with a governmental régime which has been overthrown by revolution, and hence the bankers have become persona non grata to the present authorities in the debtor country. In all of these cases an independent organization directly representative of the bondholders and not controlled by the issuing bankers might render the bondholders effective help.

Holders of defaulted bonds readily become critical, and in many cases unfairly so, of the banking house which sold the bonds. They often incline to discount the representations of the bankers as to the steps which they are taking to cure the default, to be dissatisfied with the activities shown on their behalf, and even to ascribe to ulterior motives any representations by the issuing bankers that the time for action on their behalf has not yet arrived. This state of mind often makes the bondholders an easy prey for exploitation by unqualified persons who, acting primarily in their own self-interest, offer their services in the guise of a protective committee.

Where a foreign state has placed its bonds with various American banking houses, the organization of separate committees for each issue, without some coördinating agency, may lead to conflict between the different classes of bondholders, and retard collection by any of them. Further, in many cases the bonds of a foreign state have been placed simultaneously in the American and in European markets. A central American organization would afford a more effective means of coöperating with similar organizations in England or France, for example, than would be possible if such coöperation were solely through diversified groups of bankers. This will be particularly true if negotiations for the resumption or readjustment of the debt service require collaboration with other creditor nations which have centralized organizations to deal with such situations.

Customarily the governmental machinery of European countries is exerted on behalf of their nationals' claims abroad more vigorously than is the case under our system of government. In this situation the effective protection of American holders of foreign bonds will require the utmost vigilance to counteract pressure of a political or economic character which may be brought to bear by foreign governments whose nationals are likewise the holders of defaulted foreign obligations. This will be particularly true in connection with the defaults in Central European countries. In England and France, for example, the central organizations representative of the bondholders enjoy the confidence of the governments in those countries, and this will tend to facilitate coöperation between the government and representatives of the bondholders in protecting investments which those countries have made. In most cases of default there will be a limited amount of foreign exchange available to meet the service of bond issues and even assuming that no outside pressure is brought to bear, it will be no easy task for the state in default to decide how that exchange should be allocated. Obviously the claims of English and French bondholders, represented as they are by a central organization in each country and with government coöperation, will be in a particularly favorable position to urge their claims for the lion's share of available foreign exchange. Our Department of State and our representatives abroad are undoubtedly anxious to exercise their good offices to prevent any discrimination against American bondholders, but they may often find it difficult to make this coöperation effective on behalf of a large group of American bankers who may themselves have conflicting interests and who may be tempted to play lone hands in the hope of securing special privileges for their particular bondholders. Certainly the coöperation of the Department of State and of our representatives abroad could be more easily obtained on behalf of our bondholders if our government could deal with or through some central organization of high repute, not organized for private gain and acting solely in the interest of the American investor.

As things are at present in this country it is often difficult to secure sufficiently prompt coöperation among our bankers to prevent decisions being taken abroad which are favorable to the bondholders of other countries and detrimental to American bondholders as a whole. This can best be illustrated by consideration of what has recently happened in the case of Hungary. The Government of Hungary has enacted moratorium legislation, which means that there will be default on many of the Hungarian securities held abroad. In a statement regarding the moratorium the Hungarian Government has listed certain issues which are to receive priority in securing foreign exchange. This list includes eight loans as to which, in the aggregate, European rather than American interest is overwhelmingly predominant. As a sop to American sentiment the United States Government Relief Loan to Hungary is listed second; but as the service on this Loan, now suspended by the Hoover moratorium, is in any event only about $100,000 per annum, this is not a costly exception when contrasted with the disregard of other Hungarian dollar bond issues on which the annual service charge is approximately $7,000,000 per annum. The favorable treatment afforded certain European creditors of Hungary is probably due in no small measure to their ability to act promptly and in a concerted manner and thus to secure the support of their governments. In fact the Hungarian Minister of Finance has suggested that American creditors should appoint representatives, following the example of the English creditors, to discuss the treatment of Hungarian dollar bond obligations. The incident should serve as a warning that with the European bondholders organized as they are and enjoying the support of their governments, they will be in a position to obtain more consideration from foreign debtor governments than we obtain unless American bondholders are organized to exert prompt pressure, with proper support from Washington.

It is always easier to describe the theoretical advantages to be derived from a new organization than to indicate exactly how it should be constituted and precisely what it would do. If a bondholders' protective association is to be of value it is essential to find qualified persons with the necessary prestige and authority to form the council of the association. Unless this council enjoys the complete confidence of the bondholders, and is in a position to secure the willing coöperation of the bankers, the association would do more harm than good. Further, the sponsorship of the association would have to be such that our government authorities would feel free to coöperate with it and lend it full support. In England the British Corporation is organized under a special Act of Parliament; in France the Association was constituted on the initiative of the Minister of Finance. Any corresponding American association would be more effective if it had similar government support or approval.

A large group of American citizens and American institutions are very vitally interested in the proper handling of their claims under defaulted foreign bond issues, and delicate questions of international relations may be involved in the adjustment of debts involving foreign governments. There is, therefore, a legitimate national interest in the situation which would justify the initiative of our government in arranging for a committee of eminent private citizens to study the situation and recommend whether an association should be formed and, if so, what character it should take. Much publicity has already been given to the legislation proposed by Senator Johnson to control future foreign financing. For the moment, at least, this is an academic problem, as economic conditions in general and the burnt fingers of recent investors in particular constitute a more effective brake on foreign lending than any amount of legislation. The immediate problem before us is to adjust past operations to present conditions in a way to avoid international complications and to promote the normal flow of trade and of capital between countries, and while domestic legislation dealing with the machinery for clearing up past defaults would be inappropriate, some government initiative would certainly seem justified.

An American association should not be composed primarily of representatives of the issuing bankers nor should it be organized for profit. The size of the council of the association would depend upon the number of really qualified men who would consent to serve. Probably a council of between five and ten persons would be sufficient. Persons should be selected who have no conflicting banking or commercial interests and whose time is not so completely taken up with other matters that they would be unable to give attention to the activities of the association. Probably the head of the council should give it his entire time, should receive adequate compensation, and should have a small permanent staff. Members of the council, as in the case of the British Corporation, should receive a fixed fee for attendance at meetings. It would not be easy to find the right men to act as members of such a council, but until the attempt has been made one cannot say that it is impossible.

The functions of the council of the association would probably be somewhat similar to those of the corresponding British and French associations. It would propose, probably in coöperation with the issuing bankers, the organization of particular committees to deal with particular defaults. If the issuing bankers for one reason or another failed or were unable to take timely action, the council would take the initiative alone. In many cases the council would be able to take action in situations of general interest to American bondholders where committees had not yet been formed, or where it might be deemed premature to form such committees.

Obviously the council of the association would not have any authority to commit the bondholders or in any sense to represent the bankers, unless specifically authorized to do so. It would help the bondholders to organize for their own protection, where this had not already been done, and would facilitate coöperation between the bankers in situations where the general interests of a diversified group of bondholders were at stake. In this way the association would not usurp any existing functions but it would furnish the motive force necessary to get proper action started; it would coördinate different agencies and it would bring to the attention of both bankers and bondholders any situations which might be calculated to prejudice the claims of American holders of foreign securities.

An attempt to form an American association would be useless unless there were prospects that it could be properly financed during a trial period of a few years. The financing would have to be adequate to permit the payment of the permanent staff, including the executive head of the association, and to provide for running expenses. In the case of the British Corporation, for example, the ordinary running expenses average about £12,000 per annum. This is apart from expenses incurred in litigation or the special negotiations of the various committees. Certainly several hundred thousand dollars should be available before any American association is launched. Once given an adequate start, the American association (as has proved the case with the British association) could probably care for current expenses out of the proceeds of the settlement of claims and at a very small cost to the bondholders. As the bankers would certainly be saved considerable expense by such an association, they possibly would provide some of the funds; and the New York Stock Exchange, which should certainly be represented on the council, might also be a possible contributor. Chiefly, however, the initial financing should be sought from those for whose benefit the association would be established, namely, the holders of foreign bonds, and probably largely from institutional rather than individual holders. There is a possibility, too, that the public character of the association would justify philanthropic foundations in giving their support. The cost of the association would be negligible as compared with the amount of outstanding foreign bonds in default, and if the advantages which the bondholders might derive therefrom could be brought home to them, it does not seem unreasonable to expect that funds would be forthcoming.

Despite the blow which foreign financing in the New York market has received in consequence of recent events, we shall again be lending money abroad before many years. Certainly this will be true if we are to maintain any considerable foreign trade. The experiences of both England and France, which in the past have suffered like losses on their foreign investments, show that a reverse such as we are now witnessing is not a permanent deterrent to foreign investment. However, before further American capital goes abroad, existing defaults must be settled, complicated negotiations will have to be carried through, and in connection with such negotiations refunding operations will probably be necessary. The restoration of our prosperity is in no small measure dependent upon the restoration of conditions which will permit credit to pass more normally between the nations. In working out a general settlement of foreign defaults, then, the activities of an American association for the protection of foreign bondholders, properly constituted and adequately financed, should be of great assistance -- to the bondholders, to the bankers and to the country at large.

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  • ALLEN W. DULLES, American Member of the Preparatory Commission for the Disarmament Conference at Geneva in 1926, and legal adviser to the American delegation at the Three-Power Naval Conference at Geneva in 1927
  • More By Allen W. Dulles