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Monday, June 14, 2010

Is an Orderly Restructuring of Greek Debt Feasible?

Many economists argue that the Greek government, even with the help of the European/IMF rescue package, will eventually have to restructure its debt. Just last Friday in a Bloomberg News story Thomas Mayer, chief economist of Deutsche Bank, said this about Greece: “Deficit reduction alone doesn’t solve the debt issue…Hardly anyone I know believes they can carry it out and still not restructure. This is basically the expectation across all asset classes.” He then cites a projection that Greek debt will increase from 120 percent to 150 percent of GDP with the rescue package. Former IMF economists—such as Simon Johnson, Eswar Prasad, and Raghu Rajan—share this view about a restructuring.

The reason that government officials do not want to go down the restructuring route, or even admit the possibility, is that they worry that a restructuring would be disorderly, jolt the financial markets, perhaps causing contagion. But a restructuring does not have to be disorderly and would have the added benefit of avoiding harmful future bailouts.

In a recent paper, “How to Restructure Greek Debt,” Mitu Gulati a professor at Duke Law School, and Lee Buchheit, a partner at Cleary Gottlieb in New York, lay out in detail an approach to restructuring which would likely result in very little market disruption. Gulati and Buchheit have studied or been involved in many sovereign debt restructurings over the years, so they know the relevant law and what they are talking about in the Greek case. I know them from their work on “collection action clauses,” (CACs) which emerging market countries put into their sovereign bonds as a way a way to avoid disruptive defaults and thereby give the IMF and the official sector an alternative to bailouts. Collective action clauses enable a super majority of bond holders (frequently 75%) to agree with the sovereign to change the financial terms of a bond and then require the remaining bond holders to go along. This avoids the holdout problem that usually forces a default or a bailout. In my view, collective action clauses have helped reduce bailouts of emerging market countries and improved macro policy in those countries as I argued in a post on this blog last March 2 Why Did Macro Policy in Emerging Market Countries Improve?

The problem is that the majority of Greek bonds are issued under Greek law without CACs. Only Greek bonds issued under English law have collective action clauses. However, as Gulati and Buchhiet point out, the fact that the bonds were issued under local law is an advantage because the terms can be changed by the Greek parliament. Of course, changing the terms of bonds should not be taken lightly as it raises many precedents, but Gulati and Buchheit argue that “One legislative measure that might be perceived as balanced and proportional in these circumstances, however, would be to enact what amounts to a statutory collective action clause.” So the circumstances for a Greek restructuring may actually be better than many have been led to believe.
Three other circumstances are also an advantage: First, virtually all (98 percent) of Greek government debt is denominated in Euros. Second, since all the bonds are issued under either English or Greek law, there is no complication caused by many jurisdictions. Third, most of the bonds are held by institutional investors, so the Greeks do not have to deal with thousands of small retail holdings. Economist Adam Lerrick of Carnegie-Mellon University, who also has had a lot of hands-on experience with debt restructurings, argues after a review of the Greek government's bond issue documentation, that the debt stock is in pretty good shape to be restructured. In fact he says “one could hardly have a better legal and economic structure.”