The Faculty Lounge

Greece: Argentina, Uruguay, or Twin Engine Plane?

As regular Lounge readers know, Greece has been a popular topic here of late (see links below) and with good reason: according to nearly all sources, action is near -- the only question seems to be, what sort of action? According to Paul Krugman:

The debt crisis in Greece is approaching the point of no return. As prospects for a rescue plan seem to be fading, largely thanks to German obduracy, nervous investors have driven interest rates on Greek government bonds sky-high, sharply raising the country’s borrowing costs. This will push Greece even deeper into debt, further undermining confidence. At this point it’s hard to see how the nation can escape from this death spiral into default.

Peter Boone and Simon Johnson of The Baseline Scenario think that:

There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties.  The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment.

But Felix Salmon thinks that Greece “won’t go Argentine,” and asks:

There’s another option here, which I haven’t seen mentioned: rather than Argentina 2001, why not go Uruguay 2002? Or at least somewhere in the middle, like Ecuador 1999? Given the choice — and of course they have the choice — I think that pretty much all politicians in Europe, including the Greeks, would opt to avoid the Argentine precedent. . . .

Uruguay is a case study in how a country can default in an elegant manner, use financing from multilaterals to get it over a short-term hump, and then refinance that debt in the public markets as liquidity and positive sentiment returns.

Not knowing exactly what it meant to “go Uruguay,” I asked the man who led Uruguay in “going Uruguay” -- Lee C. Buchheit, a partner based in the New York office of Cleary Gottlieb Steen & Hamilton LLP -- to put the Uruguay restructuring into the context of Greece’s troubles.  Buchheit, who has generously guest blogged with us here at the Lounge before, was the senior partner on Uruguay’s restructuring, and wrote about the deal in “Uruguay’s Innovations,” 19 J. Int’l Banking L. and Reg. 28 (2004) (with Jeremiah S. Pam); Spanish language version printed in La Ley (Supplement, “Default y Reestructuración de la Deuda Externa”, Nov. 2003).  [Don’t bother trying to locate this on the Cleary Website, which is sufficiently unnavigable that its design might have been outsourced to a major law school IT department].

Here is what Buchheit had to say on the matter:

Relocate Greece to the continent of Gondwana, give it back a currency other than Euros and reconfigure its creditor base so as to reduce the dangerously high exposure of European banks, and there seems little doubt that a thorough debt restructuring would be in order.   But the possibility of a debt restructuring is being dismissed out of hand for a Euro-located, Euro-spending and Euro-indebted Greece.  Why?

The obvious answer lies in that tell-tale word "Euro".  And while this is right, it is only partially right.  A restructuring of Greek debt might allow a worm of doubt to slither into the heads of buyers of other European government bonds, and perhaps not just governments located in the olive belt.  That worm would inevitably consume basis points on future bond coupons, but how many basis points and for how long no one can predict. 

I do not believe that this fear entirely explains the reluctance to consider a debt restructuring for Greece.

Since the commencement of the financial crisis in the fall of 2008, the official sector has not been prepared to risk aggravating the crisis by forcing distressed sovereigns to restructure their debt as a condition to receiving multilateral or bilateral aid.   There have been many beneficiaries of this policy, from Iceland to the Baltics to the Ukraine to Hungary.  Had one of these countries encountered its difficulties in more normal times, however, there is some reason to think that its creditors might have been invited to participate in a "burden-sharing" exercise (to use an almost quaint phrase).

The holders of Greek debt may similarly be sheltered from the unpleasantness of a debt restructuring, not because it would be impossible to restructure those instruments, but rather because the official sector remains exceptionally leery of inflicting any new shocks on markets that are still fragile and skittish.

Of course, if there is something approaching a return to normalcy in the next 18 months, this security blanket may quietly and insensibly slip off the side of the creditors' bed.

Uruguay in 2003 restructured ("reprofiled", to use the precise term) all of its external and local bonds.  Significantly, the restructuring was not preceded by a payment default.  All of the affected instruments were current on payments when the transaction closed on May 29, 2003, but Uruguay did not hide the fact that it was within days of running out of money.

The "reprofiling" of Uruguay's bonds involved a five-year extension of the maturity date of each instrument.  Coupons were kept the same.  There was no haircut to principal.  So basically the transaction just shifted the country's debt profile out by five years.

Did the fact of this debt restructuring keep Uruguay out of the international capital markets?  Yes.  For precisely 31 days.

Uruguay returned to the capital markets on June 30, 2003, and it has been back 18 or so times since then.

In closing, I have to share with you another “Leeism.”  I asked him about the The New York Time’s report that European leaders sought “to quash any doubts about their resolve to help Greece,” by offering a one-year aid package of up to €30 billion.  Isn’t this so far removed, I asked, from what Greece actually needs to make a go of it that it’s just throwing money away?  Why do this?  Do they really think that’s enough?  Or is this just a political move designed to make it look like Europe actually tried to do something, rather than standing by watching Greece tank? Is there something here that I don’t see?   In response, Buchheit told me The Parable of the Second Engine:

Some years ago my brother started to take flying lessons.  He trained on a single-engine aircraft.

"But surely brother mine", I said to him one fine day, "it is safer to train on a two engine aircraft in case one engine stalls".

"Lee", he responded in that tone of voice employed by all elder brothers when speaking to their siblings, "if one engine were to stall in an aircraft being flown by an inexperienced pilot, there are so many adjustments the pilot would have to make all at once that the utility of the second engine will merely be to fly everyone to the scene of the crash".

This 30 billion, and even perhaps the 30 billion after that, may wind up performing the function of the second engine.

Related Posts:

Greece Updates: You Can't Blame The Mirror For Your Ugly Face
Blame It On Derivatives, Blame it On Goldman Sachs, Blame It On the Nazis. But Don’t Blame the Greek Crisis on Greece

The Greek Crisis: Economic Meltdown or Mental One?



The Modern Greek Drama: Comedy, Tragedy, or Both?  




The Modern Greek Drama, Part 2 



Verge of the Unböring (The Modern Greek Drama, Part 3)



Is 2010 The Year of Odious Sovereign Defaults?

Ah, I see . . .

All is fine at Citigroup.  Just those pesky short-sellers causing trouble again.

            See: Citigroup Woes Due to Short Selling, Says Chief

And no need to worry about Greece anymore, now that it’s borrowed yet more money, this time at high interest rates.

            See: Greece Fears Ease After €5bn Bond Issue

Well, I certainly feel better now. . . 

Pictured at right: striking cab drivers in Athens

Greece Updates: You Can't Blame The Mirror For Your Ugly Face

From Anna Gelpern, It’s All Greek to Me FAQ (Parts I and II)

Dealbook, Greece Moves Ahead With Bond Sale

Dealbook, Governments Press Funds on European Bets

Bloomberg, U.S. Said to Tell Hedge Funds to Save Euro Records

Spiegel Online International, Graphic: Debts Without Borders

FT, Hedge funds raise bets against euro

And via Felix Salmon, one after my own heart:

Citi on sovereign CDS: “You Can’t Blame the Mirror for Your Ugly Face”

*****************************

Related Posts:

Blame It On Derivatives, Blame it On Goldman Sachs, Blame It On the Nazis. But Don’t Blame the Greek Crisis on Greece
The Greek Crisis: Economic Meltdown or Mental One?


The Modern Greek Drama: Comedy, Tragedy, or Both?  



The Modern Greek Drama, Part 2 


Verge of the Unböring (The Modern Greek Drama, Part 3)


Is 2010 The Year of Odious Sovereign Defaults?

Anna Gelpern, On Why Sovereign Is The New Black

Anna Gelpern (American), who recently did a guest post here at the Lounge on the Greek crisis, is guest blogging over at Credit Slips.   In her first post today, Anna asked Why Sovereign Is The New Black, noting that, after years on the exotic fringe of the legal academy, sovereign debt has gone mainstream and then some.  Gelpern then goes on to ponder the reasons why. 

Anna is right on with this one – even I’m blogging about the Greek crisis, an irony that can only be appreciated by those who know me well.  (For years, I instituted a ban against any mention of sovereign debt in my presence, which really is still intact: only I, and no one else, am allowed to raise the issue, and even then the discussion must relate to swaps).

But Anna is one of the (few) original sovereign legal experts and her post is well worth a read for anyone who wants to understand the Greek crisis, its historical and legal context, and why the rest of us are suddenly interested.  And while you’re at it, take a look at today’s The Lex Column in the FT: Greece / Goldman: Trojan Horse bolts.  Yea, what I said (but shorter, punchier, and to a larger circulation – as if such things mattered.)

Blame It On Derivatives, Blame it On Goldman Sachs, Blame It On the Nazis. But Don’t Blame the Greek Crisis on Greece

In an earlier post, The Greek Crisis: Economic Meltdown or Mental One?, I took issue with a recent New York Time’s article which contends that “Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.” For a variety of reasons elaborated in that post, I conclude that, “this article might be one of the least persuasive pieces of financial reporting I’ve seen since the start of the financial crisis, and that’s saying a lot.”

Since then, the Times has run two more articles, including one yesterday, blaming the Greek financial crisis on derivatives and the banks that sell them, and reporting that the Federal Reserve is investigating Goldman Sachs and other banks.  According to the same article, the SEC:

could “neither confirm nor deny the existence of an investigation,” but added that it was cooperating with United States and international regulators in examining “potential abuses and destabilizing effects related to the use of credit-default swaps and other opaque financial products and practices.”

Whatever that means.

In two interesting posts here and here, Felix Salmon takes on another Times piece on the topic, Banks Bet Greece Defaults on Debt They Helped Hide. Says Salmon:

Ben Bernanke said today that he’s looking into the issue of whether the CDS market is enabling some kind of run on the Greek government. I sincerely hope he was just being polite to his Congressional overlords, rather than buying in to this theory.

It’s worth looking at the NYT story in some detail, to see just how little sense it makes.

But today’s news brought the blame game to new levels.  Via TIME.com:

It's not quite World War III, but tension over Greece's debt crisis has ignited a battle of words between Athens and Berlin, reopening old wounds and raising the specter of Nazism. . . .

Greece's deputy prime minister, socialist stalwart Theodoros Pangalos, told the BBC that Germany still owed Greece for stealing its gold during World War II. . . .

Vassilis Tsimpidis, a Greek dockworker who protested this week against government austerity measures, echoed the sentiments of many Greeks when he said Greece's modern problems could be traced to German's wartime sins. "German people believe bad things about Greeks, but we want to remind the German people that they destroyed Greece in the Second World War," he said. "We haven't had a good life the last 40 or 50 years because of the war." Using a figure widely brandished in Greece as an estimate of Germany's war-related debt to the country, he called for Germany to "give us �70 billion to pay us for the war. That would solve all our problems."

German taxpayers, though, aren't buying that argument. In an open letter published in a Greek newspaper, German journalist Walter Wullenweber of Stern Magazine compared Greece to an ungrateful child and Germany to an aunt who is never thanked for her gifts. He calculated that if all the aid Germans have given Greeks was added up, since 1981, Germans have given each Greek $12,200. In return, Wullenweber complained, Greeks swindle the European Union and retire early. "You are by far our most expensive friend," he wrote.

No comment.

Related Posts:

The Greek Crisis: Economic Meltdown or Mental One?

The Modern Greek Drama: Comedy, Tragedy, or Both?  


The Modern Greek Drama, Part 2 

Verge of the Unböring (The Modern Greek Drama, Part 3)

Is 2010 The Year of Odious Sovereign Defaults?

The Greek Crisis: Economic Meltdown or Mental One?

Lot’s of folks have been talking about this weekend’s New York Time’s article, Wall St. Helped to Mask Debt Fueling Europe’s Crisis, in which the Times contends that “Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.”

Let’s begin with the caveat that financial innovation, including the products discussed in the Times article can serve many purposes (some nefarious), including masking risk and leverage.  We all know that.  Nonetheless, this article might be one of the least persuasive pieces of financial reporting I’ve seen since the start of the financial crisis, and that’s saying a lot.

To start, though the Times piece only vaguely describes most of the transactions at issue, at least some appear designed to rollover Greece’s debt to a later date, thus avoiding an earlier default.  Sure, that may have simply postponed the day of reckoning, but is this really Wall Street’s fault, rather than that of Greek leaders?  Deferment of this sort is only irresponsible if no action is taken to right the country’s wayward economic course – a decision firmly in Greece’s hands’, rather than Goldman Sachs’.

Second, Greece has spent more than half the years since 1800 in default – presumably, for much of that time, without the aid of financial derivatives.  (R&R, p. 98).  So who does the Times believe was fooled through Wall Street financial shenanigans?  Germany? The U.K.?  The rest of the Eurozone?  That seems unlikely.  Almost certainly the relevant powers have been aware of Greece’s precarious financial situation for some time.  Such awareness, after all, appears to be what quickly caused the loss of confidence in Greece’s ability to repay its debt after the Dubai World collapse.

Which brings me to my final point: the Times contends, no doubt correctly, that Greece entered into transactions designed primarily or solely to remove debt from the balance sheet.  But apparently, Greece didn’t need the help of sophisticated swaps to paint a rosier economic outlook than reality warranted, as it just “cooked the books” the old fashioned way.  In fact, such maneuvers are one explanation for the market’s loss of confidence.  Says Charlemagne’s Notebook in the Economist:

As a top priority, conditions would have to include a complete change in the way that economic statistics are collected in Greece, ending years of political manipulation and book-cooking so that data from Greece can be relied upon (indeed, the distrust is so deep that nobody would be astonished if even the latest Greek deficit number of almost 13% underestimates the full horror of the situation).

Did financial derivatives and U.S. investment banks play a role in the current Greek financial crisis?  Probably.  Would we still be in the same boat in the absence of financial innovation?  Almost certainly.

Related Posts:
The Modern Greek Drama: Comedy, Tragedy, or Both?  

The Modern Greek Drama, Part 2 
Verge of the Unböring (The Modern Greek Drama, Part 3)
Is 2010 The Year of Odious Sovereign Defaults?

Verge of the Unböring (The Modern Greek Drama, Part 3)

In my first post on this topic, The Modern Greek Drama: Comedy, Tragedy, or Both?, I offered the insights of Cleary Gottlieb Steen & Hamilton partner and sovereign debt guru, Lee Buchheit, on the current Greek sovereign debt drama.  In the next post, The Modern Greek Drama, Part 2, Buchheit’s frequent co-author, Duke law professor Mitu Gulati, discussed his reactions.  Today, I’m happy to introduce a post from Anna Gelpern, Associate Professor of Law at American University. 

 

 

For a supposedly exotic field, sovereign debt has been scull-splittingly, mind-numbingly boring for some time—Groundhog Day with no life lesson in the end (cite to years of Rogoff and Reinhart on centuries of sovereign badness).  Judge Thomas “Serial Embargoer” Griesa’s umpteenth Argentina order is all ennui.  I say this at some peril, owing my entire existence to a combination of Buchheit, Gulati, Argentina and Krawiec indulgence.

But really:  every few years, a country defaults or almost defaults on its debt.  Theory caption says this is all because the government over-borrowed and the creditors over-lent, which might not have happened had there been a bankruptcy-like resolution regime, and/or had the debt been predictably enforceable against assets beyond sovereign control.  Deep theory caption then wonders why we have sovereign debt at all, and bellyaches about whether the market is really a disciplinarian or a strumpet.  Disciplinarian strumpet awaits discovery in her little black swan costume.  Yawn.

Shifting the scenery slightly on the same old script, Dubai and Greece hold out a glimmer of hope for the unböring turn in sovereign debt:

·    First, the new politics make politics cool again:  how much would Abu Dhabi (Germany) take to teach Dubai (Greece-Spain-Portugal-etc.) a lesson?  Euro law and politics can turn particularly interesting, since some Euro-area exporters might quietly cheer the currency’s slide on Greek misfortunes.  Meanwhile, Argentina must work harder to get attention with the same-old-central-bank-sacking act.

·    Second, coming on the heels of the global financial bailoutfest and a bubble in crisis pulp, Greece can only confirm that policy randomness is the last best hope for moral hazard worry warts.  There is no legal barrier to bailouts.  Ever.  Really.  Whether Greece gets one is entirely a function of EU and Euro politics.  With banks and sovereigns alike, “commitment” is part of “confidence boosting.”  They work until they don’t.  The Greek lesson is that we lawyers need to diversify our shtick.

·    Third, the IMF looks much sexier in the pink light of lecturing to New York, London and Brussels while the erstwhile emerging markets get to sit smug (less Eastern Europe, but note the EU accession angle).  If the IMF co-opts the G-20 the post-World War II institutional dream might rise again from the ashes of new age informality.  The Fund might also benefit from the round of regional bailout battles:  having a common enemy in Washington may turn out to be preferable to bickering with your own neighbors.

As for the disciplinarian strumpet:  Hank Paulson serves up a reminder of the invisible hand gone frisky.  Turns out that as Russia was fighting Georgia, it tried to get Beijing to join Moscow in dumping Fannie and Freddie to get Washington to bail out the GSEs.  It’s a small world.

-- Anna Gelpern

The Modern Greek Drama, Part 2

In my last post, The Modern Greek Drama: Comedy, Tragedy, or Both?, I offered the insights of Cleary Gottlieb Steen & Hamilton partner and sovereign debt guru, Lee Buchheit, on the current Greek sovereign debt drama.  In this post, Buchheit’s frequent co-author, Duke law professor Mitu Gulati, discusses his reactions.

The spectre of a string of sovereign defaults -- remember the drama over the Dubai World default some months ago -- is back again.  It was the scare over Dubai that appeared to get the markets to ask whether there were other economies that might produce surprise defaults.  Attention moved from the usual suspects in regions like Latin America to the previously unthinkable members of the European Union.  Specifically, to Greece (and maybe now also to Italy and Spain).  Risk premiums increased and serious scrutiny was put on Greece’s finances in particular.  A couple of months later, the markets do not like what the heightened scrutiny has revealed (the words “book cooking” or their equivalent show up frequently, see Charlemagne's notebook in The Economist.).

 

But what precisely is going on?  Do sophisticated investors seriously think that Greece will be allowed to default?  Won’t the IMF or the European Union be sure to bail them out?  After all, a default in Greece would present the risk of spillover effects into its European compatriots.  And some of those other European nations appear not to be in the best of fiscal conditions (read, Italy and Spain) and others (like the U.K.) are very much hoping to be climbing out of a painful recession.

 

In theory, there is a constraint on a Eurozone bailout.  The Lisbon Treaty imposes a “no bailout” provision.  I am no expert on European treaties, but am guessing that one of the functions of this clause is to provide a protection against moral hazard.  In relevant part (see Tony Barber’s FT blog post from last week), the Lisbon Treaty says that assistance is permitted if a Eurozone member  “is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council [of national governments], on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the member-state concerned.”  That clause is probably supposed to function as a commitment device.  It tells the more profligate among the European spenders that the more austere nations (think Germany) will not come to their rescue even though the failure to rescue has the potential to cause harm to the entire Eurozone community. 

 

Well, the rubber seems to have met the road, and the question is whether anyone will take the “no bailout” clause seriously.  If the clause were taken seriously, there would be no bailout because financial profligacy (along with a dose of book cooking) are probably precisely the circumstances under which the commitment against bailouts was supposed to operate.  In other words, not the “exceptional circumstances” contemplated by the treaty.  The question though is whether the political flesh will be weak (as it usually is) and whether, so long as Greece makes some efforts in the direction of showing that it is serious about austerity, a bailout will be in the offing.  Many experts seem to think that the inconvenient clause will either be explained away or just ignored.  If so, that should lead us to ask: Does anyone take moral hazard seriously anymore?  Or have the pundits decided that the costs of moral hazard are not that high?        

 

-- Mitu Gulati

 

Much like bad luck, great blog posts on sovereign debt crises come in threes.  Stay tuned tomorrow for an upcoming post from Anna Gelpern, Associate Professor of Law at American University, who’ll add her views to the mix.

Related posts:

The Modern Greek Drama: Comedy, Tragedy, or Both? (Reactions from Lee Buchheit)

Verge of the Unböring (The Modern Greek Drama, Part 3) (Reactions from Anna Gelpern)

The Modern Greek Drama: Comedy, Tragedy, or Both?

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)

Is 2010 The Year of Odious Sovereign Defaults?

For the past decade, I’ve studiously avoided the world of sovereign debt, despite defections from friends like Al Brophy, Adam Feibelman, and Mark Weidemaier.  But with the recent collapse of Dubai World and the resulting unease in the sovereign debt markets, I, like many others, have finally come to accept the inevitable: the sovereign debt markets may soon impact my life and work in ways that I can no longer ignore. 

Guest appearances during the last week by Cleary Gottlieb Steen & Hamilton partner Lee Buchheit on Bloomberg and other media outlets drove this point home.  Lee is an excellent and knowledgeable speaker, as the interview clips linked below demonstrate, and frequently guest lectures in my classes.  One of the most memorable classes I’ve had, in fact, was a guest lecture by Lee to my seminar’s last meeting before the class graduated.  In addition to a discussion of his substantive practice, Lee discussed the importance of actually loving your work, as well as ethics issues confronted by the transactional lawyer (when your practice involves helping governments and their leaders borrow large sums of money on the international market for purposes that are sometimes unclear, and occasionally suspicious, these considerations can loom large).  I still – years later – receive emails from that group of students, and they frequently mention how much they enjoyed Lee’s visit. 

I asked Lee’s frequent co-author, Mitu Gulati, to summarize the impact of Dubai World and the subsequent Greek ratings downgrade on the markets more generally.  Below is his response:

In all of the drama of the financial meltdown over the past eighteen months or so, one segment of the global market has been relatively immune: sovereign debt (borrowing by nations).  Indeed, relative to the rest of the market, the sovereign markets have thrived.  As the domestic banking and corporate sectors of many nations have floundered, these countries have used their sovereign borrowing capacity to borrow and then bail out their weakened private sectors.  As for those nations that found themselves in trouble (as was the case in a number of Eastern European countries), the IMF was there, ready and eager to hand out funds.

 

In hindsight, it is perhaps obvious that this state of affairs was not sustainable.  At some point, sovereign borrowing inevitably reaches a level at which repayment becomes difficult (especially when the private sector bailouts don’t work).  That point was perhaps reached roughly a month ago when Dubai had a default (it was corporate debt, but of a corporate entity where the government was a major holder).  That produced concerns about the viability of other nations and the ratings downgrades of the debt of other nations (Greece being the most prominent).

 

All of this has produced much concern about whether the world is on the brink of another major financial crisis, this time with sovereigns.  And if the sovereigns default, there is no one to bail them out (except perhaps the IMF, but it does not have limitless funds).

 

In a series of radio interviews with Bloomberg, Lee C. Buchheit, a partner at Cleary Gottlieb in New York, and the guru of sovereign debt, explains the current state of affairs.  Even if you have no interest in sovereign debt or the potential for another global crisis, Buchheit is worth listening to just for the elegance with which he delivers his lines.  One of the things about these interviews that stuck out was Buchheit’s explanation for why this particular sovereign debt crisis, if it occurs, will be different. This time, it is not the usual suspects such as Brazil and Mexico who are in the worst positions. Instead, it is the industrialized nations who have borrowed so very heavily to fund their bailouts.  

 

The clips are here and here.   

Related Posts:

The Modern Greek Drama: Comedy, Tragedy, or Both? (Reactions from Lee Buchheit)
The Modern Greek Drama, Part 2 (Reactions from Mitu Gulati)
Verge of the Unböring (The Modern Greek Drama, Part 3) (Reactions from Anna Gelpern)