Greece’s private creditors are the lucky ones

by Nuriel Rubini

A myth is developing that private creditors have accepted significant losses in the restructuring of Greece’s debt; while the official sector gets off scot free. International Monetary Fund claims have traditional seniority, but bonds held by the European Central Bank and other eurozone central banks are also escaping a haircut, as are loans from the eurozone’s rescue funds with the same legal status as private claims. So, the argument runs, private claims have been “subordinated” to official ones in a breach of accepted legal practice.

The reality is that private creditors got a very sweet deal while most actual and future losses have been transferred to the official creditors.

Even after private sector involvement, Greece’s public debt will be unsustainable at close to 140 per cent of gross domestic product: at best, it will fall to 120 per cent by 2020 and could rise as high as 160 per cent of GDP. Why? A “haircut” of €110bn on privately held bonds is matched by an increase of €130bn in the debt Greece owes to official creditors. A significant part of this increase in Greece’s official debt goes to bail out private creditors: €30bn for upfront cash sweeteners on the new bonds that effectively guarantee much of their face value. Any future further haircuts to make Greek debt sustainable will therefore fall disproportionately on the growing claims of the official sector. Loans of at least €25bn from the European Financial Stability Facility to the Greek government will go towards recapitalising banks in a scheme that will keep those banks in private hands and allow shareholders to buy back any public capital injection with sweetly priced warrants.

The new bonds will also be subject to English law, where the old bonds fell under Greek jurisdiction. So if Greece were to leave the eurozone, it could no longer pass legislation to convert euro-denominated debt into new drachma debt. This is an amazing sweetener for creditors.

Moreover, the official sector began restructuring its claims (both the IMF ones and those with equal status to private ones) well before private sector creditors. Maturities were lengthened – effectively a debt restructuring – and the interest rate on those loans reduced, repeatedly.

This was despite the fact that all official loans should have been senior to the private ones, as they were all extended after the crisis struck; an attempt to resolve it rather than its cause. Historically, bilateral official (Paris Club) claims are treated as equivalent to private ones (London Club) only because such debt builds up for decades as governments lend money to former colonies or allies for political reasons. But all official lending in the eurozone began after the crisis and should have been senior to private claims. Any senior creditor that extends new financing to a distressed debtor should be given seniority; this is the principle of “debtor in possession” financing in corporate debt restructuring.

Moreover, until PSI occurred, for the last two years official loans by the Troika allowed Greece’s private creditors to exit their maturing claims on time and in full (or with a modest discount for the bonds purchased at high prices by the ECB). PSI came too little, too late.

Also, while the Eurosystem will receive, in the debt exchange, new Greek bonds valued at par, all the accounting profits from this scheme (plus the coupon on the bonds) will be transferred to governments, who have the option of passing these gains to Greece. The result is a haircut of about 30 per cent on these official sector claims. And if the ECB’s Greek bonds are passed – with no loss – to the EFSF, the latter will end up taking the losses for the difference between the bonds’ current low market price and the price at which the ECB bought them.

In conclusion, the idea that Greece’s debt restructuring is all PSI and haircuts, with no official sector involvement, is a myth. OSI started well before PSI; the PSI deal has substantial sweeteners; and with three quarters of Greek debt in the hands of official creditors by 2014, Greece’s public debt will be almost entirely socialised. Official creditors will be left to suffer most of the huge additional losses that remain likely on Greece’s still unsustainable debt in future. Moreover, the second official sector rescue of Greece will not be the last. Greece will not regain market access for at least another decade; so its fiscal and current account deficits will have to be financed with additional official resources for the foreseeable future.

So, Greece’s private creditors should stop complaining and accept the deal offered to them this week. They will take some losses, but those losses are limited and, on a mark-to-market basis, the debt exchange offers them a potential capital gain. Indeed, the fact that the new bonds are expected to be worth more than the old bonds suggests that this PSI exercise has further transferred losses to Greece’s official creditors.

The reality is that most of the gains in good times – and until the PSI – were privatised while most of the losses have been now socialised. Taxpayers of Greece’s official creditors, not private bondholders, will end up paying for most of the losses deriving from Greece’s past, current and future insolvency.

http://blogs.ft.com/the-a-list/#axzz1oSw9MlRp