Nov. 20 (Bloomberg) -- Ecuador's debt audit commission said it uncovered ``illegality and illegitimacy'' in the country's foreign obligations, findings that may give President Rafael Correa the legal basis he's sought to halt bond payments.

The commission said in a 172-page report that the global bonds due in 2012 and 2030 ``show serious signs of illegality,'' including issuance without proper government authorization. Correa, who last week withheld a $30 million interest payment on the 2012 bonds while he awaited the audit, said today that the country's bonds due in 2015 also are marred by irregularities. He called the audit results ``truly disastrous'' and ``conclusive.''

``We're not talking about the perception of debatable illegitimacy,'' Correa said after receiving the report at a public event in Quito. Government supporters ringed the auditorium where he spoke and chanted ``we owe nothing,'' ``the debt is paid,'' and ``put the thieves in jail.''

The price on the $510 million bonds due 2012 fell as much as 2.5 cents today to 24 cents on the dollar, sending yields over 70 percent, after the release of the report. The bonds have tumbled from 95 cents in mid-September as speculation has mounted that Ecuador, squeezed by a tumble in its main export, oil, will default for the second time in less than a decade.

Correa, a 45-year-old economist who has threatened to default since the 2006 presidential campaign, reiterated that the government won't pay ``illegitimate debt'' and said he'll seek to prosecute ``those responsible'' for the sale of the debt. He didn't comment on whether he plans to make the $30 million interest payment before a monthlong grace period expires in December.

Renegotiation Talks

``Correa's been pretty vocal about looking for reasons to not pay the debt,'' David Bessey, who manages more than $8 billion of emerging-market debt, including Ecuadorean bonds, in Newark, New Jersey, for Prudential Financial Inc. ``There's always been a fair amount of posturing around the whole situation. They have the ability to pay. We'll have to see.''

Ricardo Patino, the head of the audit commission, told Bloomberg News today that the Correa administration may seek restructuring talks with bondholders after completing its analysis of the debt's legality. The country's three global bonds -- the securities due in 2012, 2015 and 2030 -- total $3.9 billion.

Patino said that a 60 percent reduction in debt principal would be ``insufficient'' should the government opt for a restructuring, according to Reuters. In February 2007, Patino, then Correa's finance minister, told creditors that the government may seek a 60 percent debt reduction.

Poverty, Migration

The debt audit commission, set up by Correa last year, made no recommendations on what actions the government should take. Correa said on Nov. 15 that he'd suspend payments if the final report provided a legal basis for such a move.

The growth in Ecuador's debt over the past three decades ``occurred for the benefit of the financial sector and transnational companies and clearly went against the interests of the country,'' the commission said in the report. Paying the debt ``hurt the fundamental rights of people and communities, deepening poverty and adding to migration.''

The report says that much of the debt is illegal because usurious rates were charged; some bonds were issued without proper government authority; some bonds weren't registered with the Securities and Exchange Commission in the U.S.; and because the Federal Reserve's interest-rate increases in the late 1970s amounted to a ``unilateral raising'' of global rates.

`Fat Commissions'

``The report is so exaggerated that it weakens their claims,'' said Alberto Ramos, an economist with Goldman Sachs Group Inc. in New York. ``This is about ideology and dogma and retribution.''

Salomon Smith Barney, now a unit of Citigroup Inc., and J.P. Morgan, now known as JPMorgan Chase & Co., were cited in the report for having managed a 2000 debt restructuring without Ecuador's ``formal authorization.''

Tasha Pelio, a spokeswoman with JPMorgan in New York, and Danielle Romero-Apsilos, a spokeswoman for Citigroup in New York, declined to comment.

The South American country was pressed into taking on debts by government officials and bankers who resorted to ``blackmail and treason'' so they could make their ``fat commissions,'' Correa said.

``Enough with all this looting,'' Correa said. ``Everyone has to assume their responsibility and pay'' what they owe.

`Down With the Gringos'

The yield on Ecuador's 2012 bonds rose 1.04 percentage points to 67.28 percent at 3:47 p.m. in New York, according to JPMorgan. The bond's price dropped 0.5 cent on the dollar to 26 cents. The bonds fell as low as 14 cents on Nov. 14, after trading at 42 cents two days earlier.

``The decision to pay or not has become a political one,'' said Jorge Cherrez, president of Quito-based brokerage IB Corp. ``Our countries love to hear two things: `Down with the gringos, and I'm going to suspend debt payments.' The government can pay and will pay, but they'll leave the issue uncertain until the last minute.''

Ecuador's foreign debt totaled $10 billion as of September, according to Goldman. That equals less than 25 percent of its $44 billion annual gross domestic product. Argentina's debt, by comparison, equaled 150 percent of GDP when it defaulted in 2001, said Ramos.

``Their case for restructuring is non-existent,'' Ramos said. The country's ``debt load is low.''

Six Defaults

Ecuador, while hamstrung by a decline in oil, has the money to make the $30 million interest payment, Finance Minister Maria Elsa Viteri said on Nov. 14. Oil, which has plunged 67 percent since July amid the global financial crisis, accounts for about 60 percent of Ecuador's exports. Viteri told foreign journalists on Nov. 18 that the country's fiscal accounts remain ``strong and healthy.''

The price of five-year credit-default swaps protecting investors against default by Ecuador more than doubled this week, to a record 46.34 percentage points, according to CMA Datavision. That means it costs $4.634 million to protect $10 million of the country's debt from default.

Credit-default swaps, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality.

The South American country has defaulted six times since it separated from Gran Colombia in 1830, according to ``Debt Defaults and Lessons from a Decade of Crises,'' a book published in 2007 by Federico Sturzenegger and Jeromin Zettelmeyer.

Ecuador's notes due in 2012 and 2030 -- two of its three international bonds -- are restructured securities from the country's last default in 1999.

To contact the reporters on this story: Daniel Cancel in Quito at dcancel@bloomberg.net; To contact the reporter on this story: Lester Pimentel in New York at lpimentel1@bloomberg.net

Last Updated: November 20, 2008 16:18 EST