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Monday, July 30, 2012

Would an OSI make sense?

I am reading that an OSI (Official Sector Initiative) may be in the workings. Amounts between 70-100 BEUR. Would it make sense?


As I have argued in this blog ad nauseum, a debt forgiveness ("haircut") of sovereign debt after only a few years of economic crisis, without any one-time disasters, is absolutely the wrong thing to do because it only triggers emotions on the giving side and destroys the reputation of the receiving side.

Would the parties involved PLEASE understand the following: the level of sovereign debt is more or less irrelevant. The only thing which matters is the amount of debt service which flows through the budget!

If you think that Greece has more sovereign debt than its budget can support, just postpone the maturities and lower the interest rate to a level which the budget can support.

Instead of applying the interest rate and struggling with its effect on the budget, start the other way around. Ask how much interest expense the budget can reasonably carry. How to get to an appropriate number? Ask reputable economists to agree on a professional opinion. The question would be: what percentage of total government expenditures should Greece be expected to allocate to interest.

Presently, this percentage comes out to, I believe, around 15% of government expenditures. That is too high. Zero would be too low. So, the appropriate percentage would be somewhere between zero and 15%. Probably closer to 5% than to 10%.

And then you convert this logic into a variable interest rate structure (i. e. "interest paid will amount to, say, 5% of government expenditures"). If government expenditures go up, so does the interest expense. And vice versa.

I hear the counter-argument: creditors would never agree to such below-market rates! They don't have to! Let them charge whatever rate they deem appropriate but have them agree that only that amount which finds room in the above percentage will be paid in cash. The rest will be capitalized, payable at some point in the future. If they don't like that, ask them whether they prefer an outright "haircut".

Economically, this is has the same effect as a "haircut" for the budget. The only difference is that it is not an outright debt forgiveness forever, but only for a period of time. During this time, the creditors keep their 100% claim on principal and interest.

What is the difference between what I propose and what has been done so far (i. e. with the PSI)? A huge one! Creditors don't have to explain to shareholders and/or tax payers that, once again, they have forgiven Greece debt. If they want to, they can tell them their usual story that "we have not forgiven any debt; instead, we even make money on our loans" (accrued on paper...).

Some time later, perhaps in 20-30 years, one can still forgive the debt but by that time everything will be forgotten what is causing emotions to rise today.


  1. Hi, I really like your post but can you please explain more about how the capitalization would work in practice? And at what point in the future would the debt be paid? Thank you

    1. Debt consists of principal and interest due. Both are due whenever the loan/bond agreement says they are due (free negotiation between borrower/lenders).

      A loan is typically due in instalments; a bond is typically due in one bullet payment the end. A ten-year 10 BEUR loan might mean that there are 10 annual instalments/repayments of 1 BEUR each. A ten-year 10 BEUR bond might mean that the entire 10 BEUR is due in 10 years.

      A 99-year bond is due in 99 years from now (the principal of it). An Evergreen or Perpetual Bond is never due; i. e. it will never be repaid.

      Interest is typically payable annually. Thus, a 10 BEUR ten-year bond with a 10% interest rate would require 1 BEUR interest payments annually during the first 9 years and at the end of the 10th year, a total of 11 BEUR would be due (10 BEUR principal and 1 BEUR interest).

      Capitalization of interest means that the interest due is not paid in cash but, instead, added to the principal debt. In the previous example: the 1 BEUR interest due at the end of the first year would be added to the 10 BEUR of debt. For the second year, the debt would be 11 BEUR and the interest 1,1 BEUR, again added to principal at the end of the second year. And so forth.

      The interest expense in the budget is limited to the mount of interest paid in cash. When the 1 BEUR interest is actually paid annually, every year 1 BEUR burden the budget as an expense. When that interest is capitalized, no interest expense flows through the budget during the first 9 years. Should the total accrued interest be paid after 10 years, a huge amount of expense would go through the budget then. But, typically, one would refinance a large part of the interest due with a new bond.

      In once wrote this post about it.