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June 27, 2011 5:09 PM

Greeks Face Painful Adjustment in Debt Restructuring, Says Cleary's Buchheit

Posted by Julie Triedman

Buchheit_Lee_B&W In the 1980s, Cleary Gottlieb Steen & Hamilton partner Lee Buchheit was called upon repeatedly by Latin American governments to advise on restructuring sovereign debt. The series of defaults or near-defaults by Mexico, Argentina, and Chile, among others, threatened to overwhelm the U.S. financial system. Buchheit either led or was part of Cleary teams tapped to negotiate restructuring agreements with U.S. banks and bondholders.

Today the sovereign debt crisis leading the news is in Greece--and European Union member countries fear that a Greek default could trigger a crisis across the entire Eurozone. On Tuesday, the Greek Parliament is set to vote on the next round of austerity measures.

We recently spoke with Buchheit for his take on the problems facing Europe and the bailout-centered approach now favored by France and Germany. (Buchheit is not currently working with Greece or any of the Eurozone countries.)

German chancellor Angela Merkel said on June 17 that she supports a massive new bailout package for Greece that would include voluntary private sector participation, without any restructuring of that debt. She and other European leaders are pushing the Greek government to accept new spending cuts and tax hikes to qualify for the second bailout. What's your view of the current bailout plan?

The Europeans, or some of them anyway, fear that even a mild restructuring of the debt of a Eurozone sovereign would so unsettle the markets that investors would pull back from countries like Spain and Italy. This is the so-called contagion effect. In addition, European banks are heavily exposed to Greek paper. There is a concern that a restructuring of that paper may simply force Northern European governments to recapitalize their own banks. Finally, there is pride. There is a perception that debt restructuring is uniquely an affliction of emerging market countries.

Most economists--including the likes of [U.C. Berkeley economics and political science professor] Barry Eichengreen, [Financial Times chief economic correspondent] Martin Wolf, and Bank of England governor Mervyn King--now believe that a severe restructuring cannot be avoided. The only questions are when, and who at the time will be holding the paper. To approach a sovereign debt crisis in this incremental way, these observers say, only prolongs the agony. Everyone who has ever pulled off a Band-Aid knows that there are two ways to do it. Pulling it off slowly causes a long period of intense discomfort. Yanking it off in one pull produces agonizing discomfort, but that pain is fleeting.

What do these restructuring scenarios look like?

They can be hard or they can be soft. "Hard" means a restructuring that would slice a significant portion off the debt stock--call it perhaps 50 percent. "Soft" means preserving principal and keeping the same interest rate, but just deferring the maturity of the debts.

The current E.U./IMF approach, however, is neither of these. As Greek bonds mature, Greece draws down on its line of credit from the IMF and E.U. to repay, in full and on time, all maturing bonds. Incrementally, the debt therefore migrates out of the hands of private creditors and into the paws of the official sector, where some day it may be much harder to restructure. I liken the approach to the guy who's so afraid of getting struck by lightning that he puts on a steel helmet before he goes outside. In fact, he's attracting the lightning. 

Currently, the Greek debt is 150 to 170 percent of GDP and if you add in contingency guarantees, it's over 200 percent. That's unsupportable. With that debt load, the country will be completely unable to attract any private investment. The country doesn't die; it's on life support. But it doesn't get well.

How can a restructuring be made more politically palatable to Greece and the E.U.?

The restructuring of the debt will not avert the need for a painful adjustment by the Greeks. They have been living beyond their means. But what a restructuring says to Greek taxpayers is, you're not the only ones to experience the pain. It also allows Ms. Merkel to tell her parliament that Greece's creditors, and not just German taxpayers, are contributing to the solution.

And if you could convincingly deal with that debt stock through a restructuring, there is every reason to think Greece could eventually come back to the markets after the fiscal adjustment has been implemented.

What options are the Europeans considering?

Until just recently, there were two proposals on the table. Under the first, supported by Germany and some other European countries, Greece's bonds would have been "reprofiled" for up to seven years. Under the alternative, advocated by France and apparently accepted by the European Central Bank, the holders of Greek bonds would be asked, when those bonds matured, to reinvest the proceeds into new Greek bonds having a similar interest rate. This has been dubbed the "Vienna Initiative."

At a meeting of Merkel and Sarkozy on June 17, they appear to have agreed to give the Vienna Initiative a try. The markets, however, are deeply skeptical that this can be made to work. One obvious problem with the Vienna approach is that unless the bondholders commit in advance to reinvest in new Greek bonds, everyone will watch as each maturity falls due to find out how many holders actually reinvested. This will, I fear, tend to perpetuate a sense of crisis as things lurch on from month to month.


Read more about Lee Buchheit's views of endgame scenarios in this paper coauthored with G. Mitu Gulati of Duke Law School.

Click here for a timeline on the Greek debt crisis, courtesy of Reuters; this Dow Jones timeline covers key dates coming up in the debt crisis.

 Photo courtesy of Cleary Gottlieb Steen & Hamilton

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