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Monday, June 20, 2011

How not to manage sovereign debt problems

A country where the government manages its household well (that is: a balanced budget over an entire economic cycle) and where the economy offers attractive conditions for foreign investment will probably never experience foreign debt problems.

Countries which do not fulfill these 2 requirements will sooner or later have foreign debt problems.

A country gets into foreign debt problems when it loses the ability to obtain financing from abroad voluntarily because then it can no longer refinance maturing debt. It is never the ability to actually repay foreign debt. It is always the ability to refinance foreign debt voluntarily which is the key point to a country's solvency (and, for that matter, to any borrower's solvency).

When a country which loses the ability to service its debt with private foreign lender goes to foreign governments to request financing for that purpose, foreign governments will suggest that the country's politicians attend courses at the Kennedy School of Government in Boston. Unless, that is, those foreign governments are members of the EU.

If a country does not know how to handle such a situation (like Greece), the foreign governments should tutor them: "you first call all your private creditors to a meeting and have them appoint a Steering Committee with which you can negotiate; then you negotiate with that Steering Committee possible solutions which would be acceptable to all parties involved; and if you then still need help, then you and the Steering Committee will come to us and we will negotiate a solution which works". Unless, that is, those foreign governments are members of the EU.

The foreign lenders, of course, know that none among them can race to the exit door and cash in their chips before it is too late. That is why the lenders will agree on a "rescheduling date" which is retro-active by a few months. All banks agree that whatever exposure/risk they had on that date, they will have to keep (if they had cashed some of their chips since then, they will have to replenish them; if they had made new loans since then, those loans will be exempt from rescheduling). And foreign governments help to see that all banks do that. Unless, that is, those foreign governments are members of the EU.

The foreign lenders also know that the debtor country will need additional Fresh Money in order to remain solvent and they will agree to provide that Fresh Money on a pro-rata basis provided that Fresh Money is in a senior position to existing debt. Foreign governments help to make sure that all banks do that. Unless, that is, those foreign governments are members of the EU.

Typically, the private foreign lenders cannot impose on a sovereign debtor country economic measures which are a precondition for their going along with the rescheduling. This is where foreign governments (mostly through the IMF) come in. They negotiate economic measures on a government-to-government basis.

No foreign government will ever jump the gun and offer money to pay out private lenders at the start of this process. Unless, that is, those foreign governments are members of the EU.

Every foreign government will remain decently quiet during this process in order not to confuse the markets but they will quietly pull the strings behind the scenes. Unless, of course, those governments and Central Banks are like the EU-elites who can't keep their mouths shut.

At the end of this process, all parties involved will have a signing ceremony where everyone is happy and talks a lot. Above all, they will talk about the fact that the rescheduling came about completely voluntarily and that no one acted under duress. That would be one reason why no one could interprete the rescheduling as an Event of Default.

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