Financial Cryptography

Ecuador's default: how to tame the angry Rafael Correa

(This article was co-written with Chris Cook; although the final presentation was done by me, so I have mangled his ideas somewhat!)

The basic story: Ecuador's government is pissed & angry with the debt issuances of previous governments: accusations of bribes, misconduct, EHMs, etc. And, they are broke, or broke enough to suggest default. And it was an election promise!

So why not default? Let's run the thought experiment.

Argentina did it, and survived, or at least that theory is popular in some circles. If this were to happen, what do future partners do, like Venezuala, or the emerging Banco del Sur? Kick the Ecuadorean's sorry tail all the way to Galapogas islands, join them in default, or think about how to adopt?

It needn't be that way. The fundamental problem is that the debt has migrated from an honest contract to a dishonest circle of mutually supporting pieces. This structure no longer helps any of the participants. So here's a plan to help any bankrupt country to move to the future:

1. Default on the lot?
2. adopt a Peer to Peer system of issuance and trading, as found in this recent FT award, and as epitomised by zopa.com,
3. move the banking sector across to a service provision model, based on p2p credit
4. structure issuances as debt/equity sharing (consider LLPs). This means that bond holders are no longer simply holders of debt, they are partners and investors,
5. back the instruments with guarantees provided by mutual societies; being a member automatically gives you not only the guarantee but the incentive to look after the downstream risks,
6. then, in the bankrupcy of all the debt, replace all the old broken instruments with new equity/debt sharing instruments.

OK, so maybe we skip point 1 because we want to retain some friends. There are some pretty bad punishments that the financial world can levy you with. But think of the rest.

This is a good future model for banks. p2p investment has higher margins, and the banks do not have to risk their own capital to play. Indeed that's where they want to be, c.f., securitization, and we could argue they are already there.

But, where they are now, the risks are not properly spread to those who care for the instruments, so, say hello to financial crisis.

We just have to go the next step by engaging the players end-to-end. The real essence is to move the financial issuance of debt across to a flexible creation of debt/equity balanced contracts between issuers and investors. The details are for later.

(It goes without stressing, in this new financial structure, we would need the ability for smaller issuers to create flexible contracts together.)

Unwinding secrecy -- how to do it?

The next question on unwinding secrecy is how to actually do it. It isn't as trivial as it sounds. Perhaps this is because the concept of "need-to-know" is so well embedded in the systems and managerial DNA that it takes a long time to root it out.

At LISA I was asked how to do this; but I don't have much of an answer. Here's what I have observed:

• Do a little at a time.
• Pick a small area and start re-organising it. Choose an area where there is lots of frustration and lots of people to help. Open it up by doing something like a wiki, and work the information. It will take a lot of work and pushing by yourself, mostly because people won't know what you are doing or why (even if you tell them).
• What is needed is a success. That is, a previously secret area is opened up, and as a result, good work gets done that was otherwise inhibited. People need to see the end-to-end journey in order to appreciate the message. (And, obviously, it should be clear at the end of it that you don't need the secrecy as much as you thought.)
• Whenever some story comes out about a successful opening of secrecy, spread it around. The story probably isn't relevant to your organisation, but it gets people thinking about the concept. E.g., that which I posted recently was done to get people thinking. Another from Chandler.
• Whenever there is a success on openness inside your organisation, help to make this a showcase (here are three). Take the story and spread it around; explain how the openness made it possible.
• When some decision comes up about "and this must be kept secret," discuss it. Challenge it, make it prove itself. Remind people that we are an open organisation and there is benefit in treating all as open as possible.
• Get a top-level decision that "we are open." Make it broad, make it serious, and incorporate the exceptions. "No, we really are open; all of our processes are open except when a specific exception is argued for, and that must be documented and open!" Once this is done, from top-level, you can remind people in any discussion. This might take years to get, so have a copy of a resolution in your back pocket for a moment when suddenly, the board is faced with it, and minded to pass a broad, sweeping decision.
• Use phrases like "security-by-obscurity." Normally, I am not a fan of these as they are very often wrongly used; so-called security-by-obscurity often tans the behinds of supposed open standards models. But it is a useful catchphrase if it causes the listener to challenge the obscure security benefits of secrecy.
• Create an opening protocol. Here's an idea I have seen: when someone comes across a secret document (generally after much discussion ...) that should not have been kept secret, let them engage in the Opening-Up Protocol without any further ado. Instead of grumbling or asking, put the ball in their court. Flip it around, and take the default as to be open:

  "I can't see why document X is secret, it seems wrong. Therefore, in 1 month, I intend to publish it. If there is any real reason, let me know before then."

  This protocol avoids the endless discussions as to why and whether.

Well, that's what I have thought about so far. I am sure there is more.