Ring in the Old: Part 2: Suq Al Manakh The Crash

Symbol of the Suq Al Manakh

The Crash

When we left the Suq Al Manakh ("SAM") everything was going well, or so it seemed.  (Earlier post here). There was one worrying sign though, the premium on the deferred sales (post-dated checks) had climbed to 400% per annum.

In August 1982, a nervous or perhaps savvy investor (by some accounts a woman) presented a post dated check early. There was nothing under local law which required that the check be held until the future date. The check was due. The writer could not cover. Word got out. Panicked investors started presenting checks for payment ahead of their due dates. The entire house of cards came tumbling down. With a resounding crash.

Most of the stories you'll read about the wreckage of the SAM involve very large amounts. You'll hear that there were some 29,000 (I've seen, or think I have, the figure of 28,815) or so unpaid and apparently unpayable post dated checks issued by 6,030 or so investors totaling KD 26.7 billion (roughly US$94 billion dollars). And that was when a billion dollars was real money.  In 1984 Kuwait's GDP was US$21.7 billion. It didn't reach US$94 billion until 2006 when it surpassed that figure by US$7 billion.

The KD 26.7 billion is mind boggling, but it is the total of all the checks added together. If Investor Jawad owes Punter Jassim KD15 billion and Punter Jassim owes Investor Jawad KD14 billion, the real debt between the two is KD1 billion not KD29 billion.

There was significant concentration among the traders:

1. 18 traders were responsible for 95% of the amount. 
2. Some 8 of these traders (the so-called Knights or the Manakh, Fursan Al Manakh) were responsible for approximately 55%.
   

After the Government established a clearing house for the SAM post dated checks and netted bi-lateral deals against one another, the net amount outstanding was KD5.7 billion (US$20 billion). Still enormous in terms of Kuwait's GDP, but only about 21% of the original amount.  And cold comfort as five of Kuwait's six operating banks were bankrupt with uncollectable loans more than twice their equity. The one bank that escaped this fate, due to the prudence of its management, was the National Bank of Kuwait.

The Government's Rescue Plan

As you'd expect unwinding a problem this big was not easy. Nor was it accomplished quickly.

The first step was the passage of Law #57 in October 1982 which established:

1. A clearinghouse company to determine each trader's position after the process of conducting a bi-lateral netting of his obligations and receivables from each other trader. The first step in this process was reviewing, verifying and tabulating the payables and receivables of each trader. This process involved comparing Trader A's record of payables due to and receivables due from Trader B to Trader B's records of his dealings with Trader A and then determining the true position. 
2. A small investors' fund of KD261 million (US$1.7 billion). A small investor was someone with a loss less than KD261 thousand or US$1.7 million. Small investors were compensated for their losses. The first KD100,000 in cash. Amounts over that in Government bonds (I think six year tenors). 
3. An arbitration panel to assist traders in working out settlements, including the schedule of payments, and as well monitoring these payments. 
4. September 20, 1982 as the due date for all checks. This was done so that all obligations "matured" on the same date and all premium charges stopped as of that date. Initially the original premium (interest rate) agreed between the buyer and seller on each postdated check was retained with the only adjustment in the amount of the check being the truncation of the premium (interest) accrual on this date (20 September 1982).  Later the premium was reduced to no more than 25% per annum.
   

At this juncture the Government faced a difficult choice. Did it enforce the law on checks written against insufficient funds? To do so would mean the jailing of a large number of Kuwaitis with all the  societal and economic stresses and strains that would cause. The answer was no. The law was suspended.

The plan was that each trader would pay 100% of his net debt. A position some attributed to the influence of the then Minister of Finance and Planning, Mr. Abdulatif Yousuf AlHamad., who was reportedly adamant about the dangers of bailouts.   

Not many traders settled their debts over the next 12 months. The arbitration panel began to take legal action against some of the defaulters. Not unlike other jurisdictions in the region, the bankruptcy process is a long and difficult one. There were rather dire societal implications to taking this action  on a widespread basis as well as the crushing burden this would place on the courts.

So in April 1983, the Government looked for a new way. The first step was the creation of the Office for the Settlement of Deferred Share Sale Transactions. The office was to design and then implement a way for the settlement of the debts. Around this time, Mr. AlHamad left his position as Minister of Finance and National Planning. The Government then adopted a plan to resolve the aftermath of the Suq al Manakh through a debt settlement program that was not predicated on 100% repayment of debts.  

The idea was that each individual involved would pay according to his ability. Determining that ability would be through the calculation of a Debt Settlement Ratio ("DSR") for each investor. The DSR was the ratio of assets (cash, real estate, shares, and amounts due an investor from post dated checks) to his liabilities (the checks he had written, loans taken from banks, etc.)

An elegant, simple concept. But practical implementation was extremely difficult.

After the operation of the small trader compensation fund about 370 traders were left whose debts had to be settled.   But there was a very important complication:  Trader A's DSR was dependent on what his counterparties could pay him. That is, what amount of the face value of the post dated check in his favor he would receive.  His counterparties' ability to pay him depended on what their counterparties could pay them. If that wasn't complicated enough, many of those counterparties' ability to pay would depend on what Trader A paid.  And that as outlined above was dependent on what he was paid.  Even with the number of investors reduced to around 370, figuring all this out posed quite a challenge.

The Government turned to the Kuwait Institute for Scientific Research and some bright academics there came up with the idea of running a linear program. (Yes, that math you may have learned in business school does occasionally prove relevant in real life).

After a crude first pass, the 370 were divided into four groups: 

1. Bankrupt with No Payables from Other Investors
2. Bankrupt with Payables from Other Investors
3. Possibly Solvent (depending on the outcome of the LP exercise), and 
4. Definitely Solvent. 

The LP was run in batches for each of these groups.

The 18 names responsible for 95% of the trading were definitely bankrupt. And were the first whose DSR was calculated. DSR's were published in the newspaper. My mentor recalls seeing an article in AlQabas (where else?) listing the 18 and their individual DSRs. It took another two years to calculate the remaining DSRs.

At the time there was speculation that not everyone had disclosed all his assets. It is not uncommon in this part of the world as elsewhere that nominees (either trusted individuals or companies or trusts) hold assets to shield the identity of the true owners. Of particular concern were assets outside the State of Kuwait.

About one year after the last batch of DSR's were calculated, the Council of Ministers approved broad settlement outlines. Debtors were divided into two groups. Those with income producing collateral and those without. Those with got up to 15 years rescheduling with 0 to 7% interest. Those without 10 years and 0% interest.

There was not a great rush to settle debts. The unsettled burden of the SAM weighed on Kuwait's economy along with other factors. After the Iraqi invasion/occupation of Kuwait ended in 1991, a new tack was chosen. To aid in the recovery of the country which had suffered from the Iraqi invasion plus the lingering effects of the SAM crisis, in 1982 the Government bought up all "difficult" debts outstanding as of 1 August 1990 (the date of the Kuwaiti invasion) against the issue of Kuwaiti Government bonds. These included the unpaid Suq Al Manakh debts.

In 1993 the Government set the repayment terms for the debt it had assumed. This was followed by several further steps to give discounts for early payment of the debt, etc.   It appears from the news item about Mr. Bu Khamseen that some of these debts may still be in the process of being paid. 

Endnote:  This account of the Suq Al Manakh is not meant to be a definitive study. It is not based on original government sources nor on the accounts of insiders.  Much of it is drawn from recollections of those who worked in the area at the time supplemented with some additional written sources.