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Monday, November 13, 2017

Venezuela As An Example?

Venezuela is now doing what Greece should have done in early 2010: meet with all its creditors to discuss a restructuring of the country's debt. On one hand, Venezuela is in a worse position than Greece was in then because Venezuela does not have the benefit of belonging to a common currency zone where the major players have to fear that Venezuela's default might bring the common currency down. On the other hand, Venezuela is in a better position: since the creditors know that there is no fall-back, they might be more interested in securing a deal.

The most critical, if not the holy principle of a sovereign debt restructuring is (or rather: was until the Greek restructuring) that 'risk takers must remain risk carriers'. If, say, Deutsche Bank had an exposure to Greece before the restructuring of, say, 100, it will end up with an exposure of 100 after the restructuring. Put differently, no creditor can reduce his risk exposure at the expense of someone else (ultimately at the expense of tax payers).

In fact, the principle of 'risk takers must remain risk carriers' should be quite acceptable to creditors. Normally when they go into a debt restructuring, they eventually come out of it with only 75 on 100, or even less. In case of an official bankruptcy proceeding, it's 20 on 100, at the most. So coming out of the sovereign debt rescheduling with 100 on a 100 is quite comfortable.

The only thing which should be required of existing creditors, once 'risk takers remain risk carriers', is that they are flexible as regards interest rates and maturities. This really is not asking much when compared to a private debt restructuring where creditors might lose much (or all) of their principal claims.

What is the incentive for creditors to go along with a debt restructuring like the above? It is the hope that, after the restructuring, their assets of 100 will be of better quality than their asset of 100 was before the restructuring. How can that be accomplished?

This is where official financial institutions (ECB, IMF) and governments become involved. Someone will have to negotiate with the debtor country sounder financial policies so that its debt becomes of better quality, and that can only be other governments and/or official institutions. Someone will have to coordinate the new terms and conditions with the existing creditors. Someone will have to come up with Fresh Money which the debt country normally requires to finance budget deficits and only other governments and/or official institutions can be expected to provide that. Finally, someone will have to exert open or hidden pressure on all creditors so that they 'play ball', and that can only be their governments and/or official financial institutions.

The Greek debt restructuring was not only a significant departure from rules governing sovereign debt crises until that time but is was also extremely unfair and inequitable to everyone involved except the original creditors. Tax payers bailed out private creditors and to an important degree, EZ tax payers bailed out the creditors of non-EZ countries. For example: China, the largest contributor to Greece's current account deficit in the 2000s, did not have to make any official contribution to Greece's restructuring and, presumably, there were also Chinese banks which profited from the bail-out. Not to mention UK and US banks which were pleased by-standers profiting from the Greek bail-out without having to share in its cost.

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