By R. Thies
In the world of sovereign debt settlements, things have come a long way since Peru settled its 1889 default in part by offering creditors two million tons of guano. While making a great fertilizer, investors were understandably a little disappointed with this outcome. Luckily, the era of debt-restructuring via barter is long past and in its wake settlement terms and processes have rapidly evolved. The largest sovereign default in history, Argentina's in January 2002, is very close to being settled just 8 years and 5 short months later. Looking at the recent history of sovereign defaults gives some clues as to the outcome of a possible Greek restructuring/default, were it to happen, but leaves many questions unanswered.
In the world of sovereign debt settlements, things have come a long way since Peru settled its 1889 default in part by offering creditors two million tons of guano. While making a great fertilizer, investors were understandably a little disappointed with this outcome. Luckily, the era of debt-restructuring via barter is long past and in its wake settlement terms and processes have rapidly evolved. The largest sovereign default in history, Argentina's in January 2002, is very close to being settled just 8 years and 5 short months later. Looking at the recent history of sovereign defaults gives some clues as to the outcome of a possible Greek restructuring/default, were it to happen, but leaves many questions unanswered.
Intuitively, the Argentina default is the most instructive for the current
situation as it is both the most recent debt collapse by an industrialized
country (last year's Jamaican default didn't attract much fanfare) and the
largest in history at $82 billion. For comparison, Greece will need to
roll-over roughly €104 billion ($130 billion) between now and 2013, which does
not include additional deficit-financing as needed. Regardless, the scope is
comparable. Despite the similarities, the ongoing Argentine restructuring
process has been unique, though some of the idiosyncrasies of the process do
shed some light.
The Argentine Default and Settlement
Argentina defaulted on $82 billion of principal in January 2002 and did not even meet with its private creditors for more than a year after that time. During this time Buenos Aires government made the bold assertion that they would be settling with different bondholders on different terms, depending on the holder. The first offer from Argentina came at the end of 2003 and amounted to a 75% haircut on debt principal and no compensation for interest arrears. This was considered an egregious, unprecedented offer and was summarily rejected. In the years that followed, even the IMF (who was giving the government billions) spoke out about the fact that Argentina could afford to pay a higher percentage and eventually made settling with creditors a precondition to continuing to receive IMF funding. Eventually, a second offer was made in 2005 that was subscribed to by 76% of creditors which had various components including: swaps for US dollar denominated steep-discount bonds, US dollar-denominated bonds issued at par with steep reductions in coupon payments and some peso bonds with a combination of both. In this way, the Argentine case is relatively typical of modern sovereign restructurings in that the settlement is in the form of swaps for deeply discounted instruments.
In the five years that have followed, Argentina has made various efforts at settling with the remaining holdouts, but the one constant throughout the process has been the stark reality that it is the country that holds the power. As long as the default-country is willing to be locked out of international capital markets, the bondholders hold few cards and may only end up holding guano. The Argentina holdouts will likely settle some time this month and will receive no better terms than they were offered five years ago. While Argentina has held the cards during this process, its economy has certainly suffered as a result of the prolonged nature of the lockout. The other debt restructurings from the late 1990s- early 2000s were all settled within months, even Russia settled up within three months of its 1998 default (albeit at a steep discount). In this regard, Argentina was a special case.
Argentina defaulted on $82 billion of principal in January 2002 and did not even meet with its private creditors for more than a year after that time. During this time Buenos Aires government made the bold assertion that they would be settling with different bondholders on different terms, depending on the holder. The first offer from Argentina came at the end of 2003 and amounted to a 75% haircut on debt principal and no compensation for interest arrears. This was considered an egregious, unprecedented offer and was summarily rejected. In the years that followed, even the IMF (who was giving the government billions) spoke out about the fact that Argentina could afford to pay a higher percentage and eventually made settling with creditors a precondition to continuing to receive IMF funding. Eventually, a second offer was made in 2005 that was subscribed to by 76% of creditors which had various components including: swaps for US dollar denominated steep-discount bonds, US dollar-denominated bonds issued at par with steep reductions in coupon payments and some peso bonds with a combination of both. In this way, the Argentine case is relatively typical of modern sovereign restructurings in that the settlement is in the form of swaps for deeply discounted instruments.
In the five years that have followed, Argentina has made various efforts at settling with the remaining holdouts, but the one constant throughout the process has been the stark reality that it is the country that holds the power. As long as the default-country is willing to be locked out of international capital markets, the bondholders hold few cards and may only end up holding guano. The Argentina holdouts will likely settle some time this month and will receive no better terms than they were offered five years ago. While Argentina has held the cards during this process, its economy has certainly suffered as a result of the prolonged nature of the lockout. The other debt restructurings from the late 1990s- early 2000s were all settled within months, even Russia settled up within three months of its 1998 default (albeit at a steep discount). In this regard, Argentina was a special case.
What lessons can be drawn about sovereign restructuring?
Everything depends on the motives of the sovereign. Argentina low-balled investors because it could and was not terribly afraid of the consequences. Further, domestic political pressures encouraged stiffing foreign investors. In the Greek case, foreign could imply everyone outside of Greece, everyone outside of Europe, or theoretically, everyone outside of Germany.
Incomplete legal authority governs sovereign debt restructuring. Laws vary widely by the country in which the debt is held. For example, in the UK a majority of bondholders can agree to a settlement that the minority opposes - not so in the US or the rest of Europe.
If a sovereign wants to discriminate amongst holders, it can. This comes at a cost to the future perceived creditworthiness of the country, but in the right situation, this is an option. One can easily imagine various situations where a restructuring country protects domestic investors or the banking system of continental Europe, for example.
The IMF will continue to lend to a country after it has defaulted as long as it is making a 'credible' effort to adhere to austerity. This is particularly important because IMF programs, aimed at long-term solvency, may even mandate a maximum percent of GDP that can be devoted to interest payments. In this way, the IMF has been viewed as a sponsor of a default, usually at the expense of private creditors.
Recovery rates vary widely. The average weighted sovereign recovery rate for the period 1985-2002 was 41%, according to Moody's. Recovery rates are further affected by the cohesiveness of the bondholders. S&P estimated the recovery rate in the event of Greek restructuring to "average" 30-50%.
Everything depends on the motives of the sovereign. Argentina low-balled investors because it could and was not terribly afraid of the consequences. Further, domestic political pressures encouraged stiffing foreign investors. In the Greek case, foreign could imply everyone outside of Greece, everyone outside of Europe, or theoretically, everyone outside of Germany.
Incomplete legal authority governs sovereign debt restructuring. Laws vary widely by the country in which the debt is held. For example, in the UK a majority of bondholders can agree to a settlement that the minority opposes - not so in the US or the rest of Europe.
If a sovereign wants to discriminate amongst holders, it can. This comes at a cost to the future perceived creditworthiness of the country, but in the right situation, this is an option. One can easily imagine various situations where a restructuring country protects domestic investors or the banking system of continental Europe, for example.
The IMF will continue to lend to a country after it has defaulted as long as it is making a 'credible' effort to adhere to austerity. This is particularly important because IMF programs, aimed at long-term solvency, may even mandate a maximum percent of GDP that can be devoted to interest payments. In this way, the IMF has been viewed as a sponsor of a default, usually at the expense of private creditors.
Recovery rates vary widely. The average weighted sovereign recovery rate for the period 1985-2002 was 41%, according to Moody's. Recovery rates are further affected by the cohesiveness of the bondholders. S&P estimated the recovery rate in the event of Greek restructuring to "average" 30-50%.
What does this mean for Greece?
If a restructuring were necessary, the dynamics would be much different than they were in Argentina and other recent defaults. Namely, there is broad cohesion amongst holders of the debt, specifically in this case, French and German banks. Bargaining power of this nature would be expected to improve the terms creditors receive. Further, the ability of sovereigns to discriminate and settle with different holders on differing terms would seem to support the possibility of a Greek restructuring. In light of European central banks continuing significant purchases of Greek (and other euro-zone peripheral country) debt, a situation could be envisaged where private holders are largely protected in a restructuring and central banks receive the discounted swaps.
A key issue to monitor is the status of IMF lending to Greece. Early rumors were that the IMF would forfeit its preferred creditor status in this instance and subsequent comments from the Fund seem to confirm that is a possibility. If this multilateral debt is subordinate, it is a good indication that, at least in the eyes of the IMF, the package will be sufficient to stave off default/restructuring.
The most important thing to keep in mind when considering the possibility of a Greek restructuring is that every episode of sovereign default has looked different and with the advent of the EU's massive $950 billion package announced over the weekend, this is true now more than ever. Further, as a member of a currency union, Greece cannot pair a restructuring with a large currency devaluation, two things that have usually gone hand in hand. That factor alone is enough to conclude that a Greek default would be hugely different than anything we've witnessed. A final point to keep in mind, as the Argentina case demonstrated, as much as it may look like the IMF or other countries (Germany) are pulling all the strings, the decision at the end of the day is in the hands of the country's government. If the outlook for fiscal austerity is even more unpalatable than the consequences of a default/restructuring, then it's just a matter of time.
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