Venezuela crisis raises question: When is buying bonds unethical?

Banks benefit from a kind of tough loyalty. Most customers stick with them through thick and thin. The hassle of changing banks is too great for most people, most of the time.

But that doesn’t mean they don’t ever face pressure from their customers, their investors, or the public at large.

None other than investment bank Goldman Sachs found that out recently, in a corner of the financial market that’s rarely viewed as cause for controversy: bonds linked to a national government. The problem was the country involved: Venezuela.

After news that Goldman Sachs had bought $865 million in the debt of a state-owned oil company there, opposition leaders in Venezuela were quick to criticize Goldman for throwing out a lifeline to the repressive regime of Nicolás Maduro, who has tried to shut down parliament to cling to power and has so mismanaged the economy that food shortages are mounting. Activists protested right on Goldman’s corporate doorstep on Wall Street.

No big signs of a wider rebellion among Goldman’s core clients and investors have emerged. But as the incident prompted a defensive statement from the bank and rumblings that the Trump administration wants to discourage investments in Venezuela, it raised the question: Should ethical scrutiny of banks apply across a wider spectrum of activities – including bond investments – than is often the case?

Financial advisers who focus on ethical investing see an inner disconnect at firms like Goldman, where some investments or loans seem focused purely on profit while others are touted for their social impact.

“In the case of Venezuela, I don’t think it’s defensible from an SRI [socially responsible investing] perspective,” Kathy Stearns, a certified financial planner in Boise, Idaho, writes in an email. “Most of the major firms like Goldman have ‘arms’ that do SRI, but they have not made any institutional commitments to SRI by any means, and their [other divisions] are probably doing lots of things that their own SRI folks really disagree with.”

Clashing values

It’s a clash of cultures. On the one hand, banks are supposed to make money, and high-risk deals such as the purchase of Venezuela bonds can bring outsized returns. On the other hand, several big banks have made a big show of their sponsorship of so-called social investment bonds, which put money into programs that alleviate social problems, such as helping reduce the prison population through intensive job training or providing early childhood education to needy neighborhoods.

Further, several big names have signed the six United Nations principles of responsible investment, which state that organizations will incorporate social issues into their investment analysis and decisionmaking. Among the signatories are Goldman and other investment firms that own Venezuelan bonds: BlackRock, Fidelity, HSBC, and T. Rowe Price.

“Does the culture of the organization recognize the cognitive dissonance of this?” asks Matthew Weatherley-White, managing director of the CAPROCK Group, an impact investing firm in Boise.

Under the right circumstances, the purchase of Venezuela bonds could have a social benefit, says John Wilson, head of research at Cornerstone Capital Group, a sustainable investment adviser based in New York. He says it’s not unusual for impact investors (a special kind of socially responsible investor) to put money in unsavory companies or regimes to encourage positive change from within or to forestall a greater social disaster.

For example, if President Maduro’s government falls and a new, more democratic regime takes over and avoids default, Goldman’s lifeline may turn out to have benefited the Venezuelan people, Mr. Wilson says. “The consequences of defaulting are quite significant.”

But there’s no indication that Goldman went through any kind of social analysis before buying the oil bonds.

Should future government default?

In a statement, Goldman said it bought the bonds from another dealer, not the Venezuelan government itself. “We recognize that the situation is complex and evolving and that Venezuela is in crisis,” the bank said. “We agree that life there has to get better, and we made the investment in part because we believe it will.” Goldman also pointed out that several other prominent financial firms hold Venezuelan bonds.

Because Venezuela’s government finances are so shaky, Goldman reportedly paid about 31 cents on the dollar for bonds with a face value of $2.8 billion, in the state-owned Petróleos de Venezuela S.A (PDVSA). On May 25, the day the transaction was completed, the international reserves of the nation’s central bank jumped $442 million. Goldman declined to comment for this story.

“It is apparent Goldman Sachs decided to make a quick buck off the suffering of the Venezuelan people,” Julio Borges, head of the nation’s congress, said in a public letter to Lloyd Blankfein, Goldman’s chief executive. “I also intend to recommend to any future democratic government of Venezuela not to recognize or pay on these bonds.”

Pressure to invest

Oil-rich nations are big issuers of debt. And Venezuela’s high-risk bonds have performed so well that bond traders feel pressure to invest in them to keep up with emerging market bond indexes, argues Ricardo Hausmann, a Harvard professor and former Venezuelan planning minister.

Since 2004, an investing arm of JPMorgan Chase has offered a Venezuela-free version of its benchmark emerging-market debt index for clients who ask for it. But in an article, Professor Hausmann urged the bank to remove Venezuelan government bonds from the index. He says the firm should create a “Decent Emerging Markets index,” where nations at least have “minimal standards of respect for their citizens.”

There already is an index that does rank countries according to the social as well as the economic well-being of their citizens. The 2016 edition of the Social Progress Index ranked Venezuela in the middle of the pack of countries, but the 2017 version released this week dropped the country completely from its rankings. Venezuela’s situation is deteriorating too fast for official measures to keep up, says Michael Green, chief executive officer of Social Progress Imperative, which publishes the index.

So far, the index hasn’t been picked up as a benchmark by big institutional investors.

“There’s still some work to be done,” Mr. Green acknowledges. But “if we can validate that long-term economic success is based on strong social progress foundations and if we can get the data to be sufficiently granular and timely ... then I think it can take off very quickly.”