Saturday, July 16, 2011

Ekathimerini - Debt Restructuring/Default

The article by Stavros Lygeros describes the alternatives of what can/should be done with the debt accurately. One finds very few commentaries/announcements (be that by journalists, EU-politicians or Central Bankers) which state the facts so accurately. Instead, they seem to prefer to portray financial Armaggeddon. I would like to add some further aspects and/or clarifications.

First, a debt restructuring and a debt forgiveness (“haircut”) are 2 completely separate things. The former is the most natural thing in the world when a borrower is no longer able to service his debts. The latter is an absolute exception and should be a “no-no” for a country which is a member of the EU.

Secondly, the idea behind a haircut is to reduce the borrower’s debt service burden. In the case of a corporation which has to prepare a balance sheet, a haircut may be mandatory in order to avoid an over-indebtedness in terms of accounting (which would trigger bankruptcy). A government does not prepare a balance sheet. Instead, it accounts for actual incomes/expenses. Thus, if a government restructures its debt in such a way that principal and interest payments are deferred way into the future, it has the same economic effect as a haircut. As Mr. Lygeros correctly states: “It is the efficacy of a debt restructuring that is important, therefore, rather than the form it will take”.

Thirdly, there is a difference between private debt (loans from banks) and public debt (bonds). With private debt, a consensual restructuring of debt is under no circumstances an event of default (the whole idea of a consensual restructuring is to avoid such an event).

Fourthly, whether or not a consensual restructuring of public debt constitutes an event of default is under no circumstances so clear as everyone says it is. Here, one would have to commission a task force (rating agencies, accounting boards, lawyers, accountants) to see how an event of default could possibly be avoided. Personally, I am certain that it can be (the rescheduled Latin American bonds did not constitute an event of default with the exception of Argentina which repudiated debt outright).

Fifthly, the fact that Germany needs to plead that private banks share the burden is a joke! In a debt restructuring, the existing lenders have to share ALL of the burden, i. e. they are “stuck” with their existing exposures and hope not to have to put in too much Fresh Money. EU-politicians and Central Banks have managed to turn the principles of a normal debt restructuring upside down in the last 1-2 years!

Sixtly, “fiscal reform in combination with a consensual restructuring that will render the debt serviceable is required”. Yes, it is. But it alone won’t solve the problem. While the government indeed needs to cut its expenses, it also has to increase its revenues. Tax increases in a depressive economy won’t do the revenue side a bit of good. Reducing tax evasion would do the revenue side a lot of good but that is a separate and extremely complex issue. The only thing which will improve the revenue side on a sustained basis is a growing private sector economy which will increase tax payments without increasing tax rates.

Finally, and most importantly, what is missing in all the debates so far is a proposal to get the private sector economy going again. My own proposal is to start new production for import substitution and finance this with foreign investment (offshore funds of Greeks) where the investors are protected by a new Foreign Investment Law of constitutional rank and guaranteed by the EU so that the foreign investor does not carry any political risk.

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