Nouriel Roubini's Global EconoMonitor

Paying Greece’s Creditors: History Teaches Us Only So Much

Now that the ECB has—for the time being—effectively vetoed any bail-in of Greece’s creditors—even a modest reprofiling of the debt, which would push maturities out at unchanged coupon while keeping face value at par—the official sector is running out of options for a meaningful bail-in of creditors. The latest idea—apparently deemed acceptable even by the ECB—is a “voluntary” maintenance of the exposure of Greece’s bank creditors by inducing them to hold their exposure to the sovereign once their bond claims mature by rolling over their maturing bonds into new bonds. This option has been compared to the Vienna Initiative, which induced the cross-border exposure of foreign banks to the CEE banking system during the 2008-09 global crisis, when a number of sovereigns and banking systems in that region were at risk of rolling off the claims of foreign creditors.

However, the idea of bailing-in cross-border exposure to the banking system of a country under financial pressure has a longer history and includes similar bail-ins of foreign banks’ cross-border exposures to local banks in 1998 in South Korea, in 1999-2000 in Brazil and in 2001-02 in Turkey. The more successful experiences were the more coercive ones or when it was in the banks’ interest to maintain their exposures to their foreign affiliates.

Can the Vienna Initiative or Other Bank Creditor Bail-Ins Be Applied to Greece? No!

The application of the Vienna Initiative—or its variants in Korea, Brazil and Turkey—would not work in Greece for a number of reasons.

First, the cross-border exposure of foreign bank creditors to Greek banks has already rolled off, forcing Greek banks to rely on ECB bailouts; so there is no exposure left to bail-in.

Second, while an orderly restructuring of the bonds held by the creditors of a sovereign can be achieved with little disruption or contagion via a debt exchange, a voluntary rollover only of banks’ bonded claims against a sovereign is much more complicated, and leaves open the option of bank creditors getting rid of their exposures to traded securities before maturity. (see RGE analysis: “A How-To Manual for Plan B: Options for Restructuring Greek Public Debt”).

Third, a purely voluntary maintenance of exposure at market rates would make the sovereign’s debt even more unsustainable and, in time, ensure a default on the new bonds.

Fourth, the only way to prevent the coupon/yield on the new bonds from being close to market rates and thus unsustainable would be to provide the new bonds with seniority or some collateral, but both options are undesirable as a rollover is not a case of DIP (debtor-in-possession) financing and thus doesn’t justify such credit sweeteners.

Fifth, banks alone would be bailed in—inducing massive inequality among creditors—and only maturing bonds would be sequentially rolled over as they mature, rather than a significant part of the debt being subject to a uniform debt exchange at a single point in time (with only the latter providing meaningful debt relief for the debtor).

Sixth, there would be little debt relief and consequently the unsustainability of the debt burden of the sovereign would remain unresolved. (see “Much Ado About Relatively Little: Contagion Risks From an Orderly Greek Debt Restructuring Are Modest, Contained and Manageable”)

An application of the Vienna Initiative to the issue of Greek public debt is totally far-fetched and unrealistic. An orderly and market-oriented debt exchange is feasible, but a purely “voluntary” rollover of the exposure of banks only to maturing bonds at market yields is extremely cumbersome and makes the debt burden for the sovereign even more unsustainable. And if the rollover occurs at unchanged coupon (original yield at issuance), there is little difference between such a rollover and a more traditional and efficient debt exchange with a par bond and maintenance of the original coupon. Thus, trying to apply something that was originally designed to bail-in cross-border short-term interbank lines among banks to the bonded debt of a sovereign is a big fudge: If it is done properly, it is no different from the sort of clean debt exchange that the ECB and others abhor; and if it is done on a “voluntary” basis, it creates an even bigger and more unsustainable debt monster for the sovereign and ensures—as in the case of Argentina, which attempted a voluntary mega debt exchange at unsustainable market yields—that a disorderly default will occur in 2012 or 2013. Thus, claiming that one can apply a voluntary Vienna Initiative to the case of Greece is just a continuation of the big fudge and delusional kicking of the can down the road that the ECB and the official sector has indulged in for over a year now in Greece.

Nothing short of an orderly and market-oriented but coercive debt exchange with a par and/or discount bond is feasible and desirable to provide debt relief to the sovereign while limiting the losses of the financial system in the debtor and creditor countries. The discussion of a Vienna Initiative for Greece shows the confusion of the official sector and of some market analysts when they talk of the likelihood of massive contagion and financial Armageddon in the event of an orderly restructuring, while also claiming to support “voluntary” approaches. The latter are highly contrived and counterproductive if not outright destructive of the debt sustainability that everyone is trying to restore in distressed sovereigns.

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