By Matina Stevis
Many analysts have been pessimistic about the likely success of efforts to lower Greece’s debt burden by restructuring its government bonds.
But a new paper by financial-law academic Mitu Gulati and Jeromin Zettelmeyer of the European Bank for Reconstruction and Development, published today, puts a, sort of, positive spin on the gloom over Greek “private sector involvement” or PSI.
Messrs. Gulati and Zettelmeyer build an elegant model that calculates what it will take for private creditors to participate voluntarily in the Greek restructuring deal and therefore make PSI a success.
The two conclude that success is within reach if creditors perceive a 50% or higher probability that Greece will be forced into or opt for another debt restructuring in the medium-run. That second restructuring would probably not be voluntary.
(Mr. Gulati, who teaches at Duke University, is the co-author of two papers with Lee Buchheit, including this one, a top legal authority on sovereign-debt restructurings. Mr. Buchheit works for the law firm Cleary Gottlieb Steen & Hamilton LLP and in August 2011 was hired by Greece to advise on the restructuring.)
To recap, negotiations between the Hellenic Republic and its private creditors, which hold some €206 billion in Greek government bonds (GGBs), are ongoing. The basis for the exchange deal is the agreement of Oct. 27, reached among euro-area leaders, Greece, the International Monetary Fund and representatives of the private-sector creditors led by Charles Dallara, head of the Institute of International Finance.
The terms agreed are that the deal the deal will be voluntary, will see private-sector debt cut to 50% of its face value, and that euro-zone governments will lend money to Greece to pay for credit enhancements–incentives in the form of cash payouts or other collateral to sweeten the pill for the banks and funds. The sweeteners will total €30 billion.
The state-of-play report from colleagues in Athens and elsewhere is that there are several important points of consensus among the negotiating parties.
- Convergence on the interest rate of the new bonds around 5% (Greece wanted 4%, the IIF wanted 8%)
- New bond maturities will be 20 to 30 years
- New bonds will be issued under English law (offering more protection to the creditors holding them than does Greek law)
- Euro-area will lend Greece 15 cents to the euro for the exchange upfront to provide the sweeteners
- That leaves 35 cents in the euro of pure Greek risk for holders of the new bonds
Not too bad? Yet negotiators still have some way to go though. For example, Greece and its creditors need to agree on whether there will be a grace period before repayment starts on the principal amount of the new bonds.
Another point of contention is a demand by the creditors that the interest rate of the new bonds carry a kicker linked to Greek growth, meaning that Greece will pay a higher interest rates if the economy starts growing above a certain threshold.
And it most certainly won’t be an easy ride. Already some cracks have appeared, with the Financial Times reporting that one of the hedge funds holding Greek debt, Vega Asset Management, which even had a seat on the IIF steering committee conducting the negotiations, has left the committee and has written a letter threatening litigation.
Another threat to the process comes from the fact that Greek bonds are overwhelmingly governed by Greek law. This means that some 90% of the bond contracts offer little protection to their holders and that the Greek parliament, with a simple legislative act, could change those contracts as it likes.
This would likely violate the “voluntary” principle that everyone has agreed on to avoid a “credit event,” which would trigger payouts under credit default swap contracts. However, Greece’s newspaper of record, Kathimerini, reported some days ago that the Greek government is considering retrofitting its bond contracts with collective-action clauses to stop smaller hold-out creditors from blocking the deal.
The Gulati-Zettelmeyer paper deals with just that: the incentives for creditors to hold out and not participate in the restructuring agreement struck with the majority of Greece’s creditors.
The authors argue that the dedication to keeping the process of the restructuring voluntary presents smaller investors–especially hedge funds–with the temptation to hold out and not agree to the restructuring deal. Why would they take a haircut if the alternative is that the Greek state has to repay them in full? Such funds have no reputational concerns like the big banks holding Greek debt do, and they would have few qualms about being seen as hampering Greece’s long-term debt sustainability hopes.
What would tip the balance to minimize these holdouts? If the funds considering it perceived of a high probability that Greece would soon proceed with a second restructuring that could be involuntary.
That would leave them in a quandary. Having held out of the PSI deal, they’d still be the not-too-proud owners of GGBs under Greek law, with no protection and with a debtor who’s decided not to repay them at all!
Their alternative would be to just go along with the current deal–as the big banks probably will–and, as Messrs. Gulati and Zettelmeyer put it “have a bird in the hand”, i.e. get the 15 cents to the euro in sweeteners plus hope to get some or all of the 35 cents to the euro pledged by the Hellenic Republic.
To go back to the model the two authors build, based on several reasonable assumptions that are up to date with the current state of play, the probability that would tip the balance in favour of the potential holdouts joining in the restructuring deal is a 50% or higher chance of a second Greek restructuring.
Which is all to say: PSI will succeed if the chances of Greece defaulting on its debt in a second, hard restructuring are higher than 50%.
Isn’t it ironic?
