Monday, May 16, 2011

16/05/2011: Debt Restructuring - two insights

What if, folks... what if default or debt restructuring is the end game?

Here are two sets of thoughts on the topic. The first one is from the Lisbon Council and the second set is adopted (via my edits) from here.

Lisbon Council launched last week Thinking the Unthinkable: Lessons of Past Sovereign Debt Restructurings See , an e-brief by Alessandro Leipold, chief economist of the Lisbon Council and former acting director of the European Department at the International Monetary Fund (IMF). See for full details

Mr. Leipold argues that "European debt resolution requires a much more forward-leaning, information-driven approach, involving
  • Supplying markets with better, more timely information (including tougher banking stress tests - I would give credit here to CBofI which did carry out much more rigorous testing of Irish 4 than the EU has ever allowed to take place across the euro area)
  • Abandoning untenable timelines (such as the “no-restructurings-before-2013” mantra), and
  • Staying ahead of the game via recourse to tools such as pre-emptive bond exchange offers
Mr. Leipold draws five key lessons from past sovereign debt restructurings:
  1. Avoid Detrimental Delays. Delays in restructuring are costly (output losses, entail “throwing good money after bad” via increasingly large official bailouts, and ultimately require a larger haircut on private claims). Realistic debt sustainability analyses are needed to detect, and communicate, the possible need for debt restructuring. The EU’s “read-my-lips: no-restructuring-until-2013” sets an arbitrary and non-credible deadline: the sooner it is abandoned, the better.
  2. Repair the Banking Sector. The equation “euro debt crisis = core European bank crisis” needs to be broken. I might add that the equation 'euro debt & banks crises = European taxpayers destruction' must be broken even before we break he debt-banks link. This requires getting tough on bank stress tests, enhancing their rigour and credibility, possibly by associating the Bank of International Settlements (BIS) and IMF with European Union supervisors. Banks tests must be accompanied by much greater pressure from EU supervisors to speed up bank recapitalisation and to close down non-viable entities. Banking resolution legislation should proceed rapidly, as should creation of an EU-wide bank resolution mechanism.
  3. Remove Politics from the Driver’s Seat. The current set-up, including the European Stability Mechanism (ESM), which will begin operations in 2013), "virtually ensures that EU creditor countries’ domestic political interests will play a front-and-centre role. The recent attempted quid pro quo with Ireland whereby Europe would agree to a reduction in the cripplingly high interest rate on its loans in return for changes to the Irish corporate tax code is but one indication of this. Put simply, the decision-making and governance mechanism should be distanced from the high-pitched political positioning characteristic of EU ministerial meetings, thereby also facilitating constructive communication with markets, and helping shape expectations as needed to promote crisis resolution". I can only add to this that politicization of the economic concept of debt restructuring is also evident within the PIIGS themselves. In Ireland, we have now a virtual army of pundits - many well-meaning, of course - arguing against the restructuring on the basis of (1) 'default'=evil, (2) our debts are sustainable, and (3) current path of delaying restructuring until post-2013 is the optimal choice. These are supported, in some instances via lucrative public appointments, by the political elite.
  4. Stay Ahead of the Curve with Preemptive Exchange Offers. "Traditional bond exchange offers, made preemptively, prior to an actual default, worked well in several emerging country debt restructurings over the last decade or so, including Pakistan, Ukraine, Uruguay and the Dominican Republic. Experience indicates that such voluntary restructurings need not, contrary to some claims, be too “soft” for the debtors’ needs. Reasonably priced, and with proper incentives, deals can be concluded rapidly with negligible free riding."
  5. Do Not Expect Too Much from Collective Action Clauses. "Contractual provisions such as collective action and aggregation clauses no doubt help at the margin. But they have not shown themselves to be decisive in debt restructurings. Furthermore, they cannot help in dealing with the current stock of debt".
Much of the above prescriptions/warnings is echoed in the tables summarizing debt restructuring options available to the PIIGS that I have edited based on their original source (here).

Both provide one core lesson to us - any state close to the point of no return when it comes to its debt levels (and no one is denying that we are close to that point, all arguments today are about whether we have crossed it or not) should be:
  1. Prepared to act
  2. Prepared to act preemptively
  3. Be transparent about the problems faced
On all 3 so far our officials are failing miserably, although we are making some progress on the 3rd point...


Peter Kinane said...

Hi CG,

I am not much disposed to default, especially unilaterally, especially as it would be default somewhat within what aspires to be, or indeed is, something of a family.

There is much current dispute about the extent of our debts, now or what it will be in a few years.

As that is a rather basic factor to assessing our, and our EZ family's, situation, perhaps you would give a breakdown of the figure you arrive at.

Bye the way, any luck in getting Browne right of St. Francis of Assisi?

Ludwig Heinrich Edler said...

It seems to me that an outright default - especially given Irish commitments to the ECB and EU - cannot be undertaken without, at a minimum, a clear plan for reducing next year's deficit to zero.

I am not too au fait with this stuff, but it would seem logical to me that we must assume no one will lend to us at any reasonable rate if we default.

So it seems slightly disingenious to propose any solutions which put default on the table without first laying out a clear plan for balancing the budget.

This is not easily done. If we were to cut public sector salaries immediately by, say, 30% across-the-board, we could conceivably approach a balanced budget. But how would we cope with the communist revolution that would surely ensue?

Edmund Burke said...

What communist revolution? The long suffering private sector would applaud this to the rafters as finally public sector wages would be on a par with theirs. However there would still be their pensions to go after so the Government could run a surplus to start paying off the debt built up over the last three years, mostly to pay the outlandish public sector wages and pensions.

Fungus the Photo! said...

We are waiting for Greece to fall.

Everyone knows Neil Armstrong, Not old Buzz!

Costs? They are stimuli to some! Taxpayers are equal to the burden!