The world of international finance no longer is what it used to be 40 years ago when I grew up in it.
Then, it would have been inconceivable that a country of the 1st World (remember: as an EU member, Greece IS a country of the 1st World!) would receive a haircut on its sovereign debt after only a couple of years of crisis. Why? Because the holy principle was that sovereign debts must be honored unless one wants to chance getting excluded from financial markets for a very, very long time. And any haircut would have represented an inexcusable precedent.
Then, any country which would have retroactively changed the terms of its foreign debt documentation (like Greece did with the retroactive CAC) would have chanced its reputation as a good place for foreign investment for a very, very long time. Why? Because the holy principle was that laws cannot be changed retroactively and any such action would have represented an inexcusable precedent.
In short, the world of international finance then was a world where principle & precedent ruled. In the years since the crisis, we have seen repeated examples how principle & precedent simply went out the door. What the long-term price for that will be, no one can tell today.
A hedge fund by the name of Elliott Associates brought the sovereign country of Argentina to its knees. Argentina is in default. And? Prices on the Argentine stock exchange exploded this morning! That, too, could not have happened 40 years ago.
Elliott could not have been successful 40 years ago. Why? The international financial community would not have allowed Elliott to be successful!
When Argentina rescheduled its foreign debt in 1983, I was the chief negotiator of the 8th largest creditor bank. Argentina had around 500 creditors at the time. There were no Goldman's; no Elliott's --- they were all banks. The banks did not hold any anonymous bonds; they had official loans.
Citibank, the most exposed but also most experienced bank in Latin America then, was the supreme organizer of the sovereign debt reschedulings in Latin America and Bill Rhodes was their supreme leader. If decision makers of today would only know how Citibank and Bill Rhodes dealt with the problems then!
Every creditor bank knew, of course, that, at the end of the day, they would restructure their loans; i. e. stretch the maturities way into the future and possibly agree to lower rates. What else can you do when a country has no money to pay back its loans? No bank in its right mind would have ever expected to be bailed out by any government. Still, while the end-of-the-day result was known upfront, the activities and negotiations during the day were hectic. Principle & precedent had to be observed. Voluntariness of the participating banks had to be pretended so that loans could be kept on performing status.
Yes, there were hold-out's among the 500 banks; at least some which attempted to be hold-out's. Those hold-out's experienced what coordinated pressure of the international financial community can mean.
What if a major creditor bank had behaved like Elliott? That major creditor bank would have been reminded by the international financial community that no bank can function exclusively on its own; independent of financial partners who provide funding and other services. That major creditor bank would have been reminded that it might lose support from the international financial community if it did not 'play ball'.
Obviously, there were always some hold-out's who could not be persuaded. Typically, those were very small banks with very small exposures. To deal with them was not worth the effort. They were simply paid out by the other creditors.
What could all that mean for Greece?
Well, principle & precedent are no longer the forces which they once were. That opens a lot of new options for the conduct of debtor countries like Greece. If you know that you are not going to get crucified for violating principle & precedent, you might as well try to do it. Perhaps the Athens stock exchange explodes the day after Greece goes into default. No one can predict any longer.
There are clearly established rules of conduct in the world of international finance. They are not in writing but they are understood by all. Argentina violated just about every such rule in the book in the last 15 years. First, they unilaterally repudiated part of their debt. Then, they blackmailed creditors into an enormous haircut. And then they played a lot of silly games which might be fun games at a private party but which have no place in the world of international finance. That certainly played into the hands of Elliott because Elliott could argue that a country which plays such games shouldn't complain if creditors play similar games.
While the role of principle & precedent has been weakened dramatically in recent years, I would still argue that adhering to the rules of conduct remains as important as it has ever been. Should Greece, in the future, decide that certain principles and precendents should be tested in dealing with its sovereign debt, Greece would still be well advised to adhere to the rules of conduct. In fact, the more one adheres to the rules of conduct, the more chances one can take regarding principle & precedent.
Then, it would have been inconceivable that a country of the 1st World (remember: as an EU member, Greece IS a country of the 1st World!) would receive a haircut on its sovereign debt after only a couple of years of crisis. Why? Because the holy principle was that sovereign debts must be honored unless one wants to chance getting excluded from financial markets for a very, very long time. And any haircut would have represented an inexcusable precedent.
Then, any country which would have retroactively changed the terms of its foreign debt documentation (like Greece did with the retroactive CAC) would have chanced its reputation as a good place for foreign investment for a very, very long time. Why? Because the holy principle was that laws cannot be changed retroactively and any such action would have represented an inexcusable precedent.
In short, the world of international finance then was a world where principle & precedent ruled. In the years since the crisis, we have seen repeated examples how principle & precedent simply went out the door. What the long-term price for that will be, no one can tell today.
A hedge fund by the name of Elliott Associates brought the sovereign country of Argentina to its knees. Argentina is in default. And? Prices on the Argentine stock exchange exploded this morning! That, too, could not have happened 40 years ago.
Elliott could not have been successful 40 years ago. Why? The international financial community would not have allowed Elliott to be successful!
When Argentina rescheduled its foreign debt in 1983, I was the chief negotiator of the 8th largest creditor bank. Argentina had around 500 creditors at the time. There were no Goldman's; no Elliott's --- they were all banks. The banks did not hold any anonymous bonds; they had official loans.
Citibank, the most exposed but also most experienced bank in Latin America then, was the supreme organizer of the sovereign debt reschedulings in Latin America and Bill Rhodes was their supreme leader. If decision makers of today would only know how Citibank and Bill Rhodes dealt with the problems then!
Every creditor bank knew, of course, that, at the end of the day, they would restructure their loans; i. e. stretch the maturities way into the future and possibly agree to lower rates. What else can you do when a country has no money to pay back its loans? No bank in its right mind would have ever expected to be bailed out by any government. Still, while the end-of-the-day result was known upfront, the activities and negotiations during the day were hectic. Principle & precedent had to be observed. Voluntariness of the participating banks had to be pretended so that loans could be kept on performing status.
Yes, there were hold-out's among the 500 banks; at least some which attempted to be hold-out's. Those hold-out's experienced what coordinated pressure of the international financial community can mean.
What if a major creditor bank had behaved like Elliott? That major creditor bank would have been reminded by the international financial community that no bank can function exclusively on its own; independent of financial partners who provide funding and other services. That major creditor bank would have been reminded that it might lose support from the international financial community if it did not 'play ball'.
Obviously, there were always some hold-out's who could not be persuaded. Typically, those were very small banks with very small exposures. To deal with them was not worth the effort. They were simply paid out by the other creditors.
What could all that mean for Greece?
Well, principle & precedent are no longer the forces which they once were. That opens a lot of new options for the conduct of debtor countries like Greece. If you know that you are not going to get crucified for violating principle & precedent, you might as well try to do it. Perhaps the Athens stock exchange explodes the day after Greece goes into default. No one can predict any longer.
There are clearly established rules of conduct in the world of international finance. They are not in writing but they are understood by all. Argentina violated just about every such rule in the book in the last 15 years. First, they unilaterally repudiated part of their debt. Then, they blackmailed creditors into an enormous haircut. And then they played a lot of silly games which might be fun games at a private party but which have no place in the world of international finance. That certainly played into the hands of Elliott because Elliott could argue that a country which plays such games shouldn't complain if creditors play similar games.
While the role of principle & precedent has been weakened dramatically in recent years, I would still argue that adhering to the rules of conduct remains as important as it has ever been. Should Greece, in the future, decide that certain principles and precendents should be tested in dealing with its sovereign debt, Greece would still be well advised to adhere to the rules of conduct. In fact, the more one adheres to the rules of conduct, the more chances one can take regarding principle & precedent.
This is a one-sided post.
ReplyDeleteHonor is fine and dandy but unless the restructuring, that you are in favor of, prioritizes domestic growth and employment then social conditions deteriorate, and when social conditions deteriorate it is then that defaults are most likely to happen.
I mean, a restructuring took place in Greece, and maturities have been extended and interest rates have been slashed (although Greece castrated itself by agreeing to exchange Greek-law bonds with UK-law bonds). And what was the result? Fiscal consolidation has choked the private economy and so Greece is as close as ever to defaulting on it's external debt.
I don't mean to be hard on you, Klaus. I know that you have said numerous times how external creditors should help out Greece with getting back on it's feet, possibly by allowing it protectionist measures etc etc. Just pointing out how sticking to your obligations doesn't always end up good.
No, the Greek 'castration', as you call it, was NOT the result of the restructuring. A restructuring, or rather a rescheduling, does nothing other than reschedule EXISTING debt, and that is all that is required of banks. No haircut; no fresh money.
DeleteI have not seen one sovereing debt problem where the rescheduling alone would have solved the problem. Typically, there is additionally a Fresh Money requirement. That Fresh Money typically comes from the IMF and/or other official bodies (like the EU).
Greece's 'castration' was caused by the Fresh Money element. Had IMF/EU been prepared to lend more Fresh Money, the 'castration' would have been milder. Since they were not prepared to lend more Fresh Money than they did, the budget deficit had to be castrated as much as it was.
I am basically referring to the switch from Greek law to British law. Thus in any future dispute Greece will be taken to the British courts and there it will be dealt the same fate as Argentina now.
DeleteStill, the question remains. Greece doesn't generate enough income, enough growth, enough employment, enough economic activity, enough value etc etc to pay back it's debts. Choking it's economy (internal devaluation) didn't bring the desired results. So how is it going to pay back it's debts? Sure, you can extend and pretend, but that's not really a solution, is it?
I know that you think that FDI is the answer. I disagree because it's impossible that there's ever gonna be enough FDI to generate the value required, and also because - let's face it - it means that Greece is gonna be owned by foreigners. Nevertheless, the thing is, it ain't happening (apart from Cosco).
I guess I misinterpreted your earlier comment.
DeleteRegarding British Law, I don't think that matters all that much. I would expect that the bulk of worldwide sovereign bonds are issued under some international law instead of the local law of the borrowing country (except for the triple-A countries). I was most surprised when I learned that so much of Greece's bonds had been issued under Greek law. Most unusual and definitely not standard practice. So, British law is one of the standards and no special 'punishment' for Greece.
If a sovereign bond which is placed internationally but subject to the law of the issuing country, there is the theoretical risk that the issuing country could pass legislation declaring the bond null and void. An academic proposition but theoretically possible. That is what a foreign law is meant to protect against.
I read somewhere that there have been 56 sovereign defaults since 1990. I would suspect that most of them had bonds subject to some foreign law. If all creditors had behaved like Elliott simply because foreign law would have entitled them to do so, none of those defaults would have ever been resolved. My point is: banks agree to reschedulings NOT because they have no right to insist on full payment but, instead, because they realize that this is the only way to ever see at least some of their money.
The key instrument to avoid situations like Elliott is to have CACs in the bonds. I guess standard practice is that 75% of the creditors can commit all 100% of them but I guess there are cases where one only needs 51%. With CACs, hold-out's can be overruled by the eligible majority and they then must go along with the majority's verdict.
The grand USofA is extending and pretending once a week when they sell new T-bills. Well, they are actually not extending because they sell new bills to pay back maturing ones but they are certainly pretending that bills will be paid upon maturity. Will they be paid upon maturity? As long as the markets believe that they will, everything is fine.
As part of the PSI, most of Greece's remaining debt to private lenders was rescheduled for, I believe, 30 years. That debt has thus been 'regularized'. Have you heard anyone lately wondering whether these bonds will be paid in 30 years? Not a soul. Since the debt has been regularized and since maturities have been moved way into the future, no one worries about it now. I repeat my point: sovereign debt (or debt in general) must not necessarily appear repayable but it MUST be regularized in order for markets to sleep well.
Why not more FDI? Well, I think most of the answers you can find in the World Bank's ""Doing Business Report" where Greece ranks at the end of all EU countries (only before Romania and Bulgaria). Investors go to countries where doing buiness is easy and not hard, and they also want to feel that they are welcome in the country. Do you think that investors who read in Greek papers how many Greeks feel about Cosco get the impression that Greeks really welcome foreign investment?
This is an interesting article on the subject:
Deletehttp://www.project-syndicate.org/commentary/kenneth-rogoff-warns-that-a-broken-sovereign-debt-system-augurs-poorly-for-global-financial-stability#E99OF5FlQIveDDP7.99
I draw particular attention to the sentence: "The experience of the recent eurozone crisis stands in sharp contrast to the Latin American debt crisis in the 1980s, when banks were not allowed to exit precipitously from their loans".
That's exactly the point I have been making since the beginning of this blog. "Risk takers must remain risk carriers" was the theme which I chose to describe the process.
Whenever a debt crisis is in the making, be it sovereign or corporate, creditors chase for the exit door. They call back all the loans that they can call back before the door closes. Typically, those are short-term loans to banks. In the process, they accelerate the country's path towards illiquidity.
During the 1980s and with Latin America, Citibank invented a mechanism which closed the exit door. I will describe how this would have worked in the case of Greece.
Greece's creditors began reducing their exposurse already beginning in early 2009, but only slowly. That process accelerated after Papandreou announced the budget problem and it really accelerated in early 2010 when it became clear that Greece would require a bail-out. In early 2010, foreign banks called back billions of Euros from Greek banks which the ECB had to substitute via Target2. In May, the bail-out was agreed: risk takers could walk away and European tax payers became risk carriers.
The Citibank mechanism would have lead to the formation of a creditors' steering committee in early 2010. All creditors would have agreed that none of them could be let off the hook; that all would have to be treated pari passu and that those who had cleared the exit door in previous months would have to return.
In practice, one would have agreed on a retroactive 'rescheduling date', say 31.12.2009. All banks would have been required to report their exposures as of that date. If they had reduced their exposures since then, they would have been required to replenish them. Since the steering committe would have carried the mandate of all lending banks, its decisions would have been binding.
Suppose Deutsche had reduced its Greek exposure by 10 BEUR in early 2010 by calling back short-term loans from Greek banks. Deutsche Bank would have been required to replenish those 10 BEUR. If not, the whole rescheduling structure would have fallen apart. Since Deutsche had agreed to the formation of the steering committee; more so: since Deutsche probably would have had a leading role on that committee, there is no way that Deutsche could not have complied.
Again: all that is required of private banks in a rescheduling is that they keep and reschedule their EXISTING exposures. Instead of calling for repayment, extend maturities of principal and interest. No haircut; not Fresh Money. If you think it through, that's not really asking too much.
In the case of Greece, PSI was translated into haircut. A gigantic mistake! Private sector involvment should mean that private creditors hold on to their exposures as they are; no more. Everything else a country needs (i. e. Fresh Money) must come from official sources.