The Eurozone Dilemma - What Can Be Learned from Emerging Markets? - June 2, 2010

EMTA Special Presentation: The Eurozone Dilemma - What Can Be Learned from Emerging Markets?

Following a number of recent credit rating downgrades, and the announcement of an EU/IMF support package for Greece, on June 2, 2010, EMTA presented a panel on The Eurozone Dilemma - What Can Be Learned from Emerging Markets? This event was hosted by Bank of America Merrill Lynch and held at its offices in NYC.

This Special Presentation included a discussion of the most recent events surrounding Greece, their implications for the international financial markets, and what can be learned from historical sovereign debt restructurings in the Emerging Markets.

The panel was moderated by Daniel Tenengauzer (BofA Merrill Lynch Global Research), who cautioned at the outset that “Greece was no Emerging Market.” Other panelists (and their topics of interest) included:

Lee Buchheit (Cleary Gottlieb Steen & Hamilton) - How Will a Restructuring of Greece's Debt -- if and when it comes -- Differ from Previous Sovereign Debt Restructurings?

Alessandro Cocco (J.P. Morgan) - Overview of CDS Market Practice for European Sovereigns

Anna Gelpern (American University) - Implications of the Greek Crisis for Debt Policy and Regulatory Reform

Adam Lerrick (American Enterprise Institute) - Confusing Monetary Union with Fiscal Union: The Greek Insolvency and Bailout.

Repeating the sentiment that Greece was not an Emerging Market, EMTA Executive Director Michael Chamberlin, welcomed the audience, thanked Jane Brauer of Bank of America Merrill Lynch for her role in arranging the presentation and noted that there nevertheless were more then a few similarities between the Emerging Markets of old and what has been happening recently in Europe.

Daniel Tenengauzer opened the panel discussion by noting that the Eurozone nations generally could learn lessons from prior EM crises. He continued by distinguishing Greece from other EM countries in that its debt is mostly issued under Greek law with relatively few holders (in contrast to Argentina’s debt) in a currency that it cannot print (in contrast to Russia’s debt). He then introduced the panelists and a brief summary of their topics of discussion.

Anna Gelpern provided the legal and political context for the following lessons that could be learned from EM:

Law (in the guise of treaties, legislation and contracts) is not a substitute for political and/or economic realities. Examples of the Argentine convertibility law and a no bail-out clause demonstrate the possible over-using of hard and fast rules that may lead to credibility problems later on. She posited that the deeper the institutionalization of the rules, the more credible the local law will be treated in foreigners’ eyes.
Who is exposed is all-important to designing the right policy response. There may be structural pressures and possibly asset valuation and contagion issues that will arise. It was important to note that in the early to mid-1980’s, the commercial banks could not have absorbed the credit losses that it ultimately took to address what was then called the LDC debt crisis. In 2008, we learned that bank problems are government problems, and vice versa.
Contracts matter for how a restructuring is done, but not for whether it’s done. Greece has very flexible debt contracts, but that doesn’t tell us much about whether they will in fact restructure them.
Crises expose institutional shortcomings but also create an institutional fog. Some institutions (like the IMF) re-made themselves, while others (like the Asian Monetary Fund and the European Monetary Fund) were new creations, along with the SDRM idea. Does it make sense to create new regimes, or rather fix old ones?

Lee Buchheit noted that most of Greece’s debt is in bonds (like Ecuador, Uruguay and Argentina, but unlike Iraq), about 90% of which are governed by local law. Changing local law to facilitate restructuring would be “thermonuclearly dangerous but it is there”. Legal challenges could be made under the Greek constitution (such as the taking of property without proper compensation), Bilateral Investment Treaties or European rules. Greece’s creditors are mostly commercial banks (akin to the situation in the 1980’s prior to the Brady bond era), which creates a tense situation for the official sector that is concerned about systemic bank failures. If a restructuring is not orderly in the Greek context, it would put in jeopardy the financial well-being of many economies (at a time when such well-being is already fairly rocky). 30% of Greece’s debt is held by Greek banks and, if not handled correctly, Greece’s situation could severely destabilize its banking system.

Mr. Buchheit added that, because the Euro is Greece’s current currency, it cannot print it and thereby devalue it (as other EM countries could do in times of crisis). There are no collective action clauses (CACs) in Greek law governed bonds and little of Greek debt is held in retail hands (unlike Argentina’s debt). The IMF/EU support package is linked to an austerity program. If the performance criterias are not met, will the official sector ignore the conditions or push for their implementation? He noted that, if Greece received IMF funds, it could purchase collateral and possibly issue the Brady bond type instruments of the early 1990’s. He concluded by musing that, since the European Central Bank was the largest Greek creditor with the most votes, would it decide to buy Greek and other European bonds, would it restructure Greek debt today or in the future, and/or would it take the position that it was a preferred creditor (to the detriment of other holders of Greek debt)?

Alessandro Cocco explained that Greek debt is considered for CDS purposes as European (not EM) sovereign debt. The operative CDS provision is whether a Credit Event was triggered (and there is no differentiation between debt that is governed by Greek law vs. other countries’ law). The Credit Events that may be triggered are: failure to pay when due, repudiation/moratorium (but there must exist a technical failure to pay) or restructuring (a voluntary exchange is not a restructuring; a restructuring may be in the form of a reduction in interest or principal or delay in payment of debt in a way that binds all holders). The possible issues for a Greek restructuring are whether the Greek law governed bonds are modified due to a change in Greek law that would bind all holders and whether the UK governed bonds with CACs would bind all holders. Mr. Cocco also explained that, once a Credit Event is triggered, counterparties in a CDS transaction either settle by cash or physical delivery of the reference entity’s debt paper.

Adam Lerrick led his presentation with the basic premise that there is confusion between monetary and fiscal union in the Eurozone countries. Germany’s recent attempts to impose fiscal discipline has been rejected by Greece, Spain, Portugal and Italy. He posited that Greece is insolvent but easy to restructure with 90% of its debt in a single currency, an overwhelming majority of its debt governed by Greek law and held by institutional holders, minor CDS trading activity and strange cross-default and acceleration provisions. So, why hasn’t Greece restructured its debt yet?

Mr. Lerrick suggested that bail-outs are political, not economic, phenomenon, where perception is more important than reality, and governments are eager to control markets and legislate the problem away (while not being particularly accountable since it’s not the politicians’ own money at stake). However, the possible Greek restructuring package by the official sector was not deemed sufficient by the market and it reacted badly. See below for official information about the Greek Financing Plan. The European Union, the US and the IMF seem to be more fearful of a Greek restructuring than Greece is. Politicians do not want to be blamed for the “Great Collapse”, they want to deal with the crisis at hand, and if it gets “out of hand” they’d rather proceed with the bail-out route (although Germany and France face a hard choice – bail out Greece or their own banks). The bail-out route is the course that every government (no matter what the current political party) would take in any country.

Mr. Lerrick thinks the likely path for Greece will be continued, rolling lending by the official sector (which will become a preferred group of creditors through no real legal basis, although it is probably enjoying that status now already), with more than 50% of Greece’s debt moving from private creditor hands to the official sector. When will Greece gain more from paying than not paying its debts when due? When the political costs are too high if it doesn’t comply with official sector conditions to lending (although less than 20% of such IMF conditions are ever met, as waivers and exemptions are applied continuously). Until then, the official sector will probably continue to lend until Greece’s debt is sustainable, during which time Greece’s population will go through a long, painful process filled with high inflation and unemployment. Mr. Lerrick ended with the supposition that maybe North Europe will bail-out South Europe en masse as contagion risk spreads.

Mr. Tenengauzer concluded the panel discussion by suggesting that (1) the official sector may lend to banks that are creditors of the insolvent Greek sovereign (instead of to Greece directly), (2) the focus of the markets will be in segregating between countries that can print their own money (with the attendant concerns of possible devaluation of such currency) and those that can’t, and (3) the biggest present contagion risk is Spain (with the US situation not presenting a risk for many years to come).

Copies of the materials made available to the audience are available by Clicking Here.

Greece

Official information about the Greek Financing Plan is available at: