On Debt Reschedulings

The major difference between Greece’s debt today and Argentina’s in the 1980s is that Argentina’s debt then was mostly bank loans (about 500 banks worldwide) whereas Greece’s debt is mostly public bonds.

When debt takes the form of bank loans, a rescheduling is “relatively easy”: one knows all the lenders and one sits down with them to agree on a solution. In practice (and in simplified form) this means the following: each of the 500 banks reports to the Steering Committee the amount of its loans outstanding; the Steering Committee adds up the numbers and structures a new consolidated loan for the total. This new loan is, of course, a totally “voluntary” new loan which has one primary purpose: to repay the existing loans outstanding. The efficiency of such a structure is enormous: instead of having to deal with 500 banks individually, the borrower now deals only with the Steering Committee. The payment terms under the new consolidated loan are structured in line with the expected payment capacity of the borrower. The Loan Agreement defines Events of Default which reserve the lenders the right to intervene should things not develop as expected. However, the risk of default can be managed because it is under the control of the lenders to declare default or not.

When debt takes the form of public bonds, the rescheduling challenge is enormously greater. First, one does not officially know the holders of the bonds. Financial institutions can declare their holdings but they are not required to do so. In consequence, the holder of a bond can choose to remain anonymous which makes it impossible to involve him in any rescheduling. Secondly, the potential number of bond holders (including private investors) is likely to be so large that one cannot get all of them into a conference hall to agree on something (and if only one of them disagrees and declares default, it becomes messy; refer to Argentine bonds of 10 years ago).

Here, lawyers are challenged to find solutions. At the end of the day, a solution must be found where the number of authorized decision-makers can be reduced so that they all fit into a conference hall. It is possible but very difficult.

The rest of the process is the same as with private bank loans. A new bond is issued which the present bond holders agree to buy “voluntarily” and the proceeds of that bond are used to repay existing bonds. The terms are negotiated and structured in similar fashion as with private bank loans.

In neither of the 2 scenarios does a “haircut” become an issue. The existing debt must de jure be preserved at its nominal value even though it may today appear impossible for the borrower to ever repay the entire new bond. A forgiveness of debt may be the unavoidable result at some point in the future but – in the interest of principle and precedent – one has to try for many years to avoid it. The same economic effect of a haircut (reduction of debt service) is achieved by rescheduling principal payments way into the future and by capitalizing interest and making it payable upon maturity.

The lenders, of course, have to write down the value of the new bond to market prices today. Whether or not the bond becomes worthless in the end or recovers value depends entirely on the success/failure of the restructuring of the economy.

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