Earlier this month, we asked the question, “Is
2010 The Year of Odious Sovereign Defaults?” As predicted, Greece (and Europe more generally) will have
to answer that question soon. According
to Bloomberg:
Jan. 29 (Bloomberg) -- Greece is losing the confidence of
bondholders that it will reduce the largest budget deficit in the European
Union amid increased speculation that the country won’t be able to meet its
debt obligations.
The nation’s government bonds are the world’s worst
performers in January, losing 6 percent in local currency terms and extending
their decline over the past three months to more than 11 percent,
Bloomberg/EFFAS indexes show. Credit-default swaps tied to Greece trade at
about the same levels as Dubai when it got a $10 billion bailout from Abu Dhabi
in December. . . .
The German and French governments denied a report yesterday
in the newspaper Le Monde that European Union member states are examining ways
to provide assistance. Prime Minister George Papandreou said the country
doesn’t need to borrow from European nations. . . .
“There is no bailout problem,” the bloc’s top economic
official said in an interview with Bloomberg Television at the World Economic
Forum’s annual meeting in Davos, Switzerland. “Greece will not default. In the
euro area, default does not exist.”
For more, see Mish’s
Global Economic Trend Analysis and Charlemagne's
notebook in The Economist.
I asked Cleary Gottlieb Steen & Hamilton partner and
sovereign debt guru Lee
Buchheit for his reactions to the Greece situation and, gracious as ever,
he agreed. Buchheit’s response is below. Buchheit’s frequent co-author, Duke
law professor Mitu Gulati,
has also agreed to post about his reactions to the Greek drama, and his post
will follow in due course.
Borrowing money has several things in common with substance
abuse. It can be hideously
addictive. It provides an anodyne
to today's budgetary discomfort, while laying in store even more suffering down
the road. And, until the very end,
the afflicted will deny the problem.
When the addict is an individual or a corporation, a
mechanism (bankruptcy) exists by which the creditors who unwisely or
unknowingly fed the addiction will share the pain of withdrawal.
Sovereign borrowers are different.
With any luck, the government that resorts to borrowing as a
means of covering its budget deficits in normal times (such deficits being the
product of a politically understandable aversion to taxation coupled with an
equally understandable urge to spend) won't be around when the time comes to
repay the debts. This may trouble
the conscience of statesman; it doesn't seem to disturb the sleep of most
politicians.
But when the day of reckoning does arrive for the sovereign
debtor, however, no formal bankruptcy process can be relied upon to shift part
of the pain to the creditors. For
the addicted sovereign borrower, the choices are (i) impose fiscal austerity to
a degree that will convince some group of lenders -- official or commercial --
to refinance the maturing (inherited) debt stock until such time as good
fortune can allow the debt stock to be rolled over on a purely voluntary basis,
or (ii) default and restructure as best one can.
Neither option is pleasant.
The first requires the government to convince its citizens to
accept a degradation of their standard of living in order to expiate the sins
of their profligate forebears.
The second (restructuring), quite apart from national
humiliation, forces the debtor country into the financial equivalent of cold
turkey. Whatever residue of the
debt is left after the restructuring (as well as all other expenditures) must
be serviced out of current government revenues with no expectation of new
credit inflows for an indeterminate period of time.
Greece finds itself facing these two options. The smart money -- at least the
buyers of Greek bonds this week -- bet on the first alternative: self-imposed
fiscal austerity at a level that will unlock a bailout (from the Eurozone, a
coalition of willing Eurozone members or perhaps the IMF).
There are three risks.
First, the required fiscal austerity proves to be politically or
socially untenable and is abandoned.
Second, the expected bailout fails to arrive notwithstanding the
government's adjustment efforts.
Third, someone (like the IMF) demands BOTH fiscal austerity AND a debt
restructuring. This, after all,
was precisely what dozens of over-indebted countries, starting with Mexico in
1982, were told to do in order to win IMF support.
-- Lee C. Buchheit
Lee’s point about the stark choices faced by sovereign
borrowers reminded me of Reinhart and Rogoff’s discussion of the importance of
willingness to pay versus ability to pay in the sovereign context. (Coincidentally, I’ve assigned This
Time Is Different: Eight Centuries of Financial Folly to my Ethics in
Financial Crises class this month, and that chapter is particularly salient
right now). According to Reinhart
and Rogoff (pp.51-52):
[C]ountry default is often the result of a complex
cost-benefit calculus involving political and social considerations, not just
economic and financial ones. Most
country defaults happen long before a nation literally runs out of resources.
In most instances, with enough pain and suffering, a
determined debtor country can usually repay foreign creditors. The question most leaders face is where
to draw the line. The decision is
not always a completely rational one.
Romanian dictator Nikolai Ceausescu single-mindedly insisted on
repaying, in the span of a few years, the debt of $9 billion owed by his poor
nation to foreign banks during the 1980s debt crisis. Romanians were forced to live through cold winters with
little or no heat, and factories were forced to cut back because of limited
electricity.
Few other modern leaders would have agreed with Ceausescu’s
priorities.
Related posts:
The
Modern Greek Drama, Part 2 (Reactions from Mitu Gulati)
Verge
of the Unböring (The Modern Greek Drama, Part 3) (Reactions from Anna
Gelpern)
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