Greater Prague‘s Unrepaid Debt (and the Czech State’s Liability for It)
This year marks the centenary of the the creation of so-called Greater Prague, when Prague was connected with 38 outlying suburbs to create one administrative unit. Amidst all the upcoming municiple celebrations, exhibitions, and self-congratulatory back-slapping, spare a thought for how this expansion was financed and why, 100 years later, some debts remain unrepaid.
It is a story of small-mindedness and sleight-of-hand which, unsurprisingly, doesn't appear in Prague's official civic history. Nonetheless, it reflects an ongoing pettiness and provincialism which the founding fathers of the Republic: Presidents Tomas Masaryk, Edvard Benes and Prague Mayor Karel Baxa fought so hard to counter. Here is the story, readers can judge for themselves.
1922: Financing the Expansion
The expansion and integration of Prague's existing districts with surrounding suburbs, including Dejvice, Karlín, Smíchov, Vinohrady, and Žižkov, required massive investment into Prague's infrastructure. To finance this expansion, in 1922, the City issued a large $7 ½ m dollar denominated bond and a similarly sized £1 ½ m ($7 ½ m) sterling bond.
While the $15 m of additional debt more than doubled the indebtedness of Prague, it also enabled huge additional investment into the City. The proceeds being used to finance "the construction of an electric power station, the purchase and erection of gas plants and the extension of the waterworks and of the tramways throughout the former suburbs."
Not only was Prague's bond issue significant due to its size, it was also historically significant, following on as it did from the trail-blazing success of Czechoslovakia's dollar and sterling bond issues earlier in 1922. The first such international bond issue by any central-European State following WW1.
The inflow of foreign currency associated with these bond issues (and subsequent bond issues, such as, the City of Carlsbad 1924 and First Bohemia Glass Works 1924) brought in much needed foreign currency and helped stabilise the whole Czechoslovak economy. While elsewhere in Europe, there was chaos and instability, the 20's are remembered as La Belle Époque for Czechoslovakia.
1946: Maturity Prolonged But Czech State Guarantees Debt
As Prague's official history explains: ''The German occupation [during WW2] left the city's economy in complete disarray, the worse came after it. With the nationalization in 1945, the city permanently lost its financial institutions, power plants and gas stations - its most valuable economic entities.'' Against this backdrop, in 1946, the maturity of the bonds issued by Prague in 1922 were extended, with the Czechoslovak State assuming responsibility for their repayment. While investors may have hoped State backed debt was safer than municiple debt, they would soon be disabused.
1952: Czechoslovakia Defaults on its Dollar Loans
Following the Communist putch is 1948, Czechoslovakia defaulted on all its dollar debt obligations in 1952 and its sterling debts in 1959. While a settlement on the sterling default was quickly reached, negotiations with regard to the dollar debt dragged on for decades. It was only in 1984 that a Memorandum of Procedure was agreed with a Final Settlement signed in 1986.
1987: Czechoslovakia Defaults on ''Final Settlement''
Under the terms of the 1986 Final Settlement, bondholders who had accepted and submitted their bonds according to the earlier Memorandum of Procedure, stood to receive 95 ½% of the face value of their bonds (in addition to an initial 2 ½% downpayment already received when their bonds were stamped as eligible). Most bondholders were therefore entitled to 98% of the face value of their bonds.
This should have been the end of the matter. Officially, the offer ran through calendar year 1987, but then, suddenly and inexplicibly, the money ran-out in May 1987. While most professional investors did receive their payment, as they had submitted their bonds promptly for repayment, many private investors, especially those based outside the major cities or abroad, who submitted their bonds later were told the money had ''run-out''.
So what happened? The terms of the final settlement (which the Czech MoF hasn't disclosed) called for the Czechoslovak Ministry of Finance to provide 80% of the funds needed to fund the Settlement, with additional money ''as shall be required''. However, those additional funds were never sent leaving mostly small investors, often Czech emigres/patriots living outside the big cities who, according to the President of the Foreign Bondholders' Protective Council (FBPC), had ''bought the bonds in their local churches and societies to support the motherland'' with no compensation. Incredibly, the Czechoslovak Ministry of Finance had defaulted on the Settlement when it was estimated just an additional $1/4m was required to fully fund the settlement. Just how small-minded can one get?
1989: Czechoslovakia Invokes Sovereign Immunity
The skulduggery didn't end there. A small group of investors, who happened to hold bonds that had been subject to a New York Supreme Court judgement against the Czechoslovak State (the so called Augstein bonds), were offered just 20% of their face value.
When the Augstein Bondholders tried to sue both the Czechoslovak MoF and the Foreign Bondholders' Protective Council (FBPC), the body representing bondholders, the Czechoslovak State invoked Sovereign Immunity (Jacob Oliner, v. Czechoslovak Socialist Republic and Foreign Bondholders Protective Council (1989)). As a result, the action against the FBPC had to be dismissed as well. It was clear, with the use of Sovereign Immunity, bondholders had no means of redress. Shaken by the lawsuit, the FBPC became inactive and disbanded.
1993: Collective Amnesia
From 1993 onwards, the Czech State, its agencies, and the City of Prague issued bonds once more. Their offering circulars make no mention of the history of default, the 'Final Settlement' or use of Sovereign Immunity. With the FBPC inactive, the Czech MoF has been careful not to disclose the terms of the 1986 Settlement. Furthermore, in a conflict of interest, the MoF, the same institution that defaulted on the bondholders' Settlement, through much of the 1990's, also acted as the financial market Supervisory body tasked with protecting investors.
Questioned by the author about the remaining unrepaid bonds, the MoF's responses have been surreal. Repeated requests, not only to the MoF, but also to the to the MoF's former (Irving Trust NY), and current (CNB), paying agent for a copy of the Final Settlement were ignored[i]. In written correspondence, the MoF asserted that the Statute of Limitations expired in 1986, 20 years after the bonds were meant to have matured, completely ignoring the existence of the1986 Settlement and subsequent default on that Settlement in 1987.
In this strange Kafka-esque world, the 1986 Settlement no longer exists. Maybe it never existed?
Default, Deceit and Non-Disclosure
Unfortunately for the Czech Ministry of Finance, the recent discovery of a signed copy of the 1986 Final Settlement, along with supporting documents, in the FBPC archives at Stanford University Libraries, has laid bare the nature of the MoF's default, and subsequent deceit and non-disclosure. Without these documents, the truth, would never have emerged.
While it was an incredible act of official pettiness to have defaulted on the Settlement when only an additional $1/4m was required: To have not mentioned the default (and use of Sovereign Immunity) in subsequent prospectuses, and ignored bondholders' requests for a copy of the Settlement, only adds to the sense of official impropriety.
That both the City of Prague and Czech State have, since 1993, issued new bonds while still in default on their prior bonds beggars belief. However, the crowning hypocrisy must surely be the MoF's 2018 centenary issuance of bonds In the Name of the Republic. No mention, of course, of the relatively recent default on a Settlement that should have seen the original Czechoslovak bonds repaid (along with the City of Greater Prague & Carlsbad/Karlovy Vary bonds).
Will the Dollar Bonds Finally Be Repaid?
100 years after being issued, will the City of Prague and other dollar bonds subject to the 1986 Settlement finally be repaid? To find out, in a personal capacity, the author recently initiated legal proceedings against the Czech Ministry of Finance with a small representative sample of these unrepaid bonds, most stamped as eligible and assenting to the 1986 Settlement. While five of the bonds presented for payment relate to the Czechoslovak State loan (1922), two City of Carlsbad (1924) bonds and one City of Greater Prague (1922) bond have also been included.
The author is requesting the State finally honours the terms[ii] of the 1986 Settlement.
Jeremy Monk
Prague. 21st June, 2022
Afterword
The author believes that by honouring the 1986 Settlement, at minimal cost, the new Czech government can help rebuild trust and confidence in the Czech capital market which has suffered from years of scandal and controversy. Any improvement in trust would, of course, be reflected in a lower 'risk premia' and lower debt service costs.
It should be stressed, that while the author holds some of these uncancelled bonds, neither AKRO investiční společnost, a.s. or any of the funds it manages has any direct interest in these bonds or in fact holds any Czech government debt.
Many of AKROs clients, especially former investors in the CS Funds, whose funds were 'tunneled' in 1997 after repeated acts of maladministration by MoF officials, are only too aware of the broken culture and lack of accountability which has hitherto prevailed at the MoF.
For the purposes of reference, there is a link below to the Settlement the MoF has refused to divulge.
Disclaimer
This article does not constitute investment advice or a recommendation to buy or sell any security.
[i] Computashare/Irving Trust referred the author to the issuing authority. The CNB, meanwhile, asserted that ''the CNB's scope of competence does not extend to dealing with State debt or alleged state debt.''
[ii] Pay the 95 ½% face value. Bonds with a face value of $2,900 have been presented.