Nouriel Roubini's Global EconoMonitor

Greece’s Private Creditors Are the Lucky Ones

From the Financial Times:
A myth is developing that private creditors have accepted significant losses in the restructuring of Greece’s debt; while the official sector gets off scot free. International Monetary Fund claims have traditional seniority, but bonds held by the European Central Bank and other eurozone central banks are also escaping a haircut, as are loans from the eurozone’s rescue funds with the same legal status as private claims. So, the argument runs, private claims have been “subordinated” to official ones in a breach of accepted legal practice.

The reality is that private creditors got a very sweet deal while most actual and future losses have been transferred to the official creditors.

Even after private sector involvement, Greece’s public debt will be unsustainable at close to 140 per cent of gross domestic product: at best, it will fall to 120 per cent by 2020 and could rise as high as 160 per cent of GDP. Why? A “haircut” of €110bn on privately held bonds is matched by an increase of €130bn in the debt Greece owes to official creditors. A significant part of this increase in Greece’s official debt goes to bail out private creditors: €30bn for upfront cash sweeteners on the new bonds that effectively guarantee much of their face value. Any future further haircuts to make Greek debt sustainable will therefore fall disproportionately on the growing claims of the official sector. Loans of at least €25bn from the European Financial Stability Facility to the Greek government will go towards recapitalising banks in a scheme that will keep those banks in private hands and allow shareholders to buy back any public capital injection with sweetly priced warrants.

The new bonds will also be subject to English law, where the old bonds fell under Greek jurisdiction. So if Greece were to leave the eurozone, it could no longer pass legislation to convert euro-denominated debt into new drachma debt. This is an amazing sweetener for creditors.

Moreover, the official sector began restructuring its claims (both the IMF ones and those with equal status to private ones) well before private sector creditors. Maturities were lengthened – effectively a debt restructuring – and the interest rate on those loans reduced, repeatedly.

This was despite the fact that all official loans should have been senior to the private ones, as they were all extended after the crisis struck; an attempt to resolve it rather than its cause. Historically, bilateral official (Paris Club) claims are treated as equivalent to private ones (London Club) only because such debt builds up for decades as governments lend money to former colonies or allies for political reasons. But all official lending in the eurozone began after the crisis and should have been senior to private claims. Any senior creditor that extends new financing to a distressed debtor should be given seniority; this is the principle of “debtor in possession” financing in corporate debt restructuring.

Moreover, until PSI occurred, for the last two years official loans by the Troika allowed Greece’s private creditors to exit their maturing claims on time and in full (or with a modest discount for the bonds purchased at high prices by the ECB). PSI came too little, too late.

Also, while the Eurosystem will receive, in the debt exchange, new Greek bonds valued at par, all the accounting profits from this scheme (plus the coupon on the bonds) will be transferred to governments, who have the option of passing these gains to Greece. The result is a haircut of about 30 per cent on these official sector claims. And if the ECB’s Greek bonds are passed – with no loss – to the EFSF, the latter will end up taking the losses for the difference between the bonds’ current low market price and the price at which the ECB bought them.

In conclusion, the idea that Greece’s debt restructuring is all PSI and haircuts, with no official sector involvement, is a myth. OSI started well before PSI; the PSI deal has substantial sweeteners; and with three quarters of Greek debt in the hands of official creditors by 2014, Greece’s public debt will be almost entirely socialised. Official creditors will be left to suffer most of the huge additional losses that remain likely on Greece’s still unsustainable debt in future. Moreover, the second official sector rescue of Greece will not be the last. Greece will not regain market access for at least another decade; so its fiscal and current account deficits will have to be financed with additional official resources for the foreseeable future.

So, Greece’s private creditors should stop complaining and accept the deal offered to them this week. They will take some losses, but those losses are limited and, on a mark-to-market basis, the debt exchange offers them a potential capital gain. Indeed, the fact that the new bonds are expected to be worth more than the old bonds suggests that this PSI exercise has further transferred losses to Greece’s official creditors.

The reality is that most of the gains in good times – and until the PSI – were privatised while most of the losses have been now socialised. Taxpayers of Greece’s official creditors, not private bondholders, will end up paying for most of the losses deriving from Greece’s past, current and future insolvency.

16 Responses to “Greece’s Private Creditors Are the Lucky Ones”

DiranMMarch 8th, 2012 at 8:15 am


You make some good points about OSI creditors being analogous to the principle of “debtor in possession” financing in corporate debt restructuring as opposed to the older approach of bilateral claims being 'pari passu'. Also noted is the generous terms of the PSI haircut with cash payout and losses simply reflecting market to market.

What I really question here – an our differences may not be very large – is that this is simply another fudge and EZ obfuscation which does not really bring any notable debt relief to Greece at a tremendous price to Greek national sovereignty, reducing Greece to colony status of the Eurozone.

DiranMMarch 8th, 2012 at 8:15 am

Already Greece in a dismal mess from years of over-dependency on the EZ as a failed developmental model. Greece has become a welfare dependency case. Like demoralized and broken inner city families who are stuck in abject poverty and dependent on food stamps for survival, so is Greece as a poor and increasingly desperate relative of the EZ. The Greek political elite only know how to live on transfer money and bailouts. Creditors are increasingly in possession.

With the magnitude of economic pain, there may some eventual social uprising and revolt, but so far the EU mindwashing is working and the Greek middle class clings to the Euro currency even living in frozen homes without money to pay for heating oil.

I have not seen such a success in political ideology since the Soviet system of satellite countries in Eastern Europe, albeit in the end the result was not so pretty. The other side of the equation is how the creditor countries are going to explain their massive loan losses on Greece to their voters and cover this. The Soviet system ultimately impoded.

Time will tell here.

DiranMMarch 8th, 2012 at 8:25 am

Personally as a Greek citizen, I would have preferred admission of insolvency, hard default and negotiated departure from the Eurozone. The Greek Political elite are a cowardly, weak-minded lot with no vision or sense of national pride; but then how to take such a bold move without substantial preparation whereas these guys work off the cuff for their next Ponzi loan instalment.

On the other hand, the EU Elite have very incentive that Greek people do suffer badly as an example, so other EZ Periphery members never dare to leave themselves, echoing how the Soviets dominated Eastern Europe. It is not a very pretty system. It is very hard to see how this is going to be economically or politically sustainable.

Aegean1972March 8th, 2012 at 9:37 am

if Greece had a dynamic technocratic gvmnt, i would too be pro-drachma and full force to making Greece a magnet for tourist investments as well as energy-investments.
But since our current political elites are incapable of pretty much anything (with the exception of PM Papademos), then i d rather have a euro-nanny managing things, than default and become the new Argentina, in an era of very slow growth, haircuts and deleveraging. Plus if Greece exits, then hell breaks loose in the EU and the domino will start. A political and financial domino that will gradually take all PIIGS out of the EU and the crisis (panic) will violently spread across the Atlantic and soon enough across Asia.

So imo its better for Greece to stay within the EU "fence" (at least for now). The slightest rumble can eventually bring the whole house down.
This is what all of us are starting to realise.

It will roughly cost 2-3 trillions to save the euro-periphery (with no "divorces"). But it ll cost a heck of alot more if one by one the ladies (greece, italy, portugal, spain) start to exit and pandora's box opens.

SouthernStarsMarch 8th, 2012 at 9:06 am

I last posted that the safest places to be and the ones international capital would migrate to would be those where commerce was governed by English law. I had no idea that English law itself would be so conveniently and easily transported to another country, on an ad hoc basis, when it suits.
The idea as Roubini outlines it is quite frightening and is a further illustration, if more was needed, that Greece is a ' failed state'.
The definition of a failed state, of course, is in the hands of the powerful, and Greece is currently not powerful.
I wonder what this means for the rest of Europe?

Aegean1972March 8th, 2012 at 10:11 am

After reading Roubinis recent article about the "3 divorce senarios within Europe" i have been skeptical. I think Europe will either "make or break" in the next years. You cant have a divorce of Greece and not expect more divorces from the rest of the PIIGs. And you cant have divorces from the PIIGS without affecting the core (even France). Lately even leading-core countries like Holland are openly skeptical about the euro. If we have such euro-skepticism so early, what will happen in 3 years from now when the rest of europe will start to have a good taste of the recessional-bitterness that Greece has been tasting for over 4 years now? What will the Dutch taxpayers be saying then? "The hell with the euro?" Recession hasnt even knocked on their doors and yet many europeans are having 2nd thoughts about the euro.

Austerity-gvmnts are falling like autumn leafs.

The future of europe doesnt look very bright and Roubini is one of the first to "sense" that and put it in writing with logical time-patterns. "If so…then so and so…which eventually will bring so and so…It makes sense to me.

Only growth can save Europe and they need to act fast. Greece first.

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JasonMarch 12th, 2012 at 7:52 pm

I have to disagree with Nouriel here. Any future losses are likely to be disproportionately transferred to Private not Official debtors, since Private debt has been subordinated to Official debt with the ECB being able to swap its debt and thus avert taking direct losses.

In another year of so when Greece will perhaps realize that it would have been best to have a hard default and leave the Eurozone, when they will need bailout number three, the very same private bondholders who got this "sweet deal" will pay the heaviest price, given the subordination of the debt they are holding (the ECB and others will again extricate themselves at the expense of ordinary bondholders). This will be even more telling given the large ratio of Official to Private debt.

Finally, at an average of 23 cents on the dollar, i hardly see how the new Greek bonds are any more valuable than the old ones…


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