If there isn't a joke that has the punch line "when the bird s**t runs out," there should be. The trouble is, that in the case of Nauru, not only isn't it a joke, it's a real tragedy.
Nauru, which 20 years ago had a trust fund worth more than $2 billion, is worse than broke. Barring a miracle, it has the potential of becoming a failed state, doomed by years of profligate spending, corruption, mismanagement, and outright theft of the assets that were put in the trust. Now one of the world's smallest nations, a country that was right and truly destroyed to generate billions in revenues, is in default on a $162 million mortgage loan provided by General Electric (NYSE:GE). Now GE has asked receivers to sell off the only real assets Nauru has remaining: its Australian real estate portfolio, valued at more than $200 million.
This is a story of how investing without discipline can be extraordinarily expensive. It's also a story about profligate spending, keeping untrustworthy counsel, and a simple warning that spending money that you do not have can create an absolute disaster that will impact generations.
I'm sure that I don't need to tell you that Nauru is an independent country, since you, like me, certainly read ad nauseam about Nauru in high school civics class.
No? OK, then I'll sum it up: Nauru is a speck in the central Pacific Ocean, a nation consisting of a single island of 8 square miles (seven Naurus would fit into Washington, D.C.), and about 10,000 people. Soon after Nauru gained its independence from Australia in 1968, it became one of the wealthiest nations on the planet, courtesy of thousands of years' worth of calcified guano that covered much of the island. Nauru sold off the high-grade phosphates present in the guano for use in everything from fertilizers to toothpaste, but it was clear that this revenue stream would soon run out. In the meantime, Nauru's bird doo was pure gold for the islanders. In the early 1980s, Nauru had a per-capita income approaching $50,000 -- double that of the U.S. -- good enough to place it among the ultra-wealthy. Now the country is poverty-stricken, and now the assets that were meant to provide for its people when the phosphates were exhausted are gone as well.
Cradle to grave
As has happened in other low-population countries with nationalized natural resource wealth, what sprang up in Nauru was an amazing cradle-to-grave nanny state. More than 95% of all jobs on Nauru were provided by the government, and in many cases, employees were paid whether they ever showed up to work or not. Also, since the government owned the Trust, there was a great deal of political intrigue as various factions attempted to gain control of both the country and its purse strings. Meanwhile, Nauru's government turnstile failed to keep its spending at a level that kept the country's principal intact -- it refused to recognize that revenues from mining had decreased dramatically starting in 1980, and chose to keep its spending on everything, such as free flights to Australia for health care and higher education. There's an excellent summation in Pacific Magazine from September 2001. The Nauruan government routinely spent $30 million to $50 million more than its receipts in the 1990s -- a spectacular misuse of the funds that everyone should have recognized were supposed to support the country for future generations.
Even as the wheels were coming off and the last of the phosphates were being mined in Nauru, a recent administration -- the same one that signed the GE deal -- had a tendency to commandeer Air Nauru's single Boeing (NYSE:BA) 737 and fly it on shopping trips to places like Singapore and New York, "paying" for the junkets with worthless checks drawn on the decidedly funds-free Bank of Nauru. The Bank would just forward the bills on to the Nauru Phosphates Royalty Trust.
Earlier this year, a new government took over in Nauru, led by Ludwig Scotty, a man renowned for his honesty and incorruptibility. He's most likely about 20 years too late, but he is most certainly too late by six years. In 1998, the Nauruan government owed its annual interest payments to residents under the terms of the royalty trust. Rather than biting the bullet and saying that the money just wasn't there, the government instead went to its ace in the hole -- its massive real estate portfolio in Australia, including the Nauru House, which was at its completion the tallest building in Melbourne.
So desperate was the Nauruan government for the money that it agreed to kneecracker terms on the loans from GE: 9% interest, a million-dollar management fee, and most astoundingly, a clause granting GE $18 million to compensate it for the increase in property value. David Adeang, the new minister of finance for Nauru, calls that clause "unconscionable."
I agree, such a clause comes straight out of the subprime credit industry. But two things must be remembered: First, the Nauruan government at the time freely entered the agreement under these terms. And second, it's not as if Nauru had a pristine credit rating by 1998 -- it was essentially tapping the only real asset it had left, all for the sake of a government keeping itself in power.
Nauru defaulted on its loans in January, but GE gave the country 120 additional days to scramble to make payment. Trouble is, there was nothing left for the country to fall back upon. Real estate revenues were insufficient, the bird s**t had run out, Air Nauru's one remaining airplane has a lien in excess of $13 million against it -- the country's only hope was that a government -- most probably Australia -- would bail it out. The Australian government rightly demurred, stating that it did not wish to get involved in what is a commercial affair.
A fairy tale that ends in tears
And so Nauru is still broke, its per-capita annual income having dropped to below $2,800. GE is a business, and, as such, its prerogative and its mandate is to protect its shareholders' assets, not those of a debtor in default that happens to be a sovereign nation at the end of its rope. But it's not like a country can simply go into bankruptcy, liquidate, and fade into history. As such, the stakes for Nauru, now nearly bereft of its portfolio and the ability to generate additional revenues, are somewhat larger than its tiny speck in the middle of the Pacific. In the1990s, Nauru's banking laws might as well have been purpose-built for international money laundering. Some estimates hold that $70 billion of ill-gotten funds from Russia cycled through Nauruan banks, coming out untraceable on the other side. What will happen when a broken country has nothing left to lose?
Bill Mann owns no shares of any company mentioned in this article. He has been to the Nauru House in Melbourne, but never to Nauru itself. The Fool is investors writing for investors.
