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Greece: An Effective Model for Europe’s Next Wave of Debt Restructuring?

Atlantic Council

March 27, 2012

11:00AM ET

Operator: Excuse me, everyone. We now have Ms. Anna Gelpern, professor of law at American and Georgetown University, Mr. Mitu Gulati, professor of law at Duke University, and Mr. Alexei Monsarrat, director of global business and economics at the Atlantic Council on the line. Please be aware that each of your lines is now in a “listen only” mode. At the conclusion of our guest’s remarks, we will open the floor for your questions. At that time, instructions will be given as to how to proceed if you would like to ask a question. I would like to turn the conference over to Mr. Monsarrat who will be offering some introductory remarks and introducing Professors Gelpern and Gulati. Mr. Monsarrat, please begin.

Alexei Monsarrat: Okay. Thanks very much, Operator, and good morning, everyone, and welcome to the call. Thanks for joining us and today, we’re going to be having a discussion on Greece’s recently concluded debt agreement and what that might meant for the rest of Europe. As many of you no doubt have seen there’s quite a bit of noise starting to percolate about what this might mean for Portugal or Spain and whether contagion for Greece really has been stopped or if we’re now going to see more of these kinds of restructuring deals. So, we have brought on to the line two experts on this issue to help enlighten us. Anna Gelpern is a visiting professor of law at Georgetown and a professor of law at American University. She’s contributed to international initiatives on financial reform and sovereign borrowing, most recently as part of the Second Warwick Commission and as an expert for the United Nations Conference on Trading Development. Anna is also a fellow at the Peterson Institute and at the George Washington University School of Law, so she has a number of hats that she wears and has served previously at the Treasury Department covering all of these issues on international debt and finance. Mitu Gulati is a professor at Duke and an expert on debt contracts, the evolution of contract language, and the history of international financial law. He works closely with Lee Buchheit of Cleary Gottlieb Steen & Hamilton to develop what ultimately became Greece’s restructuring plan. This was through a paper that he and Lee co-wrote earlier in 2010. And so, we’re really looking forward to hearing from both of you, Anna, Mitu, and I would turn it over pretty much immediately to you and, Mitu, I believe you’re going to lead us off.

Mitu Gulati: Thank you. Thank you, Alexei. Thank you to all of your colleagues who made this possible. So, I’ll start and I’ll try to be really quick; although, I am very fond of the sound of my own voice. But a couple of disclaimers: I’m going to draw extensively from the work of my co-authors, Jermaine Settlemeyer, Frank Schmanz, Lee Buchheit, and Anna herself. And I won’t give them credit, largely because most of them work with institutions that would not want to be associated with anything that I say. And the second disclaimer is that I’m primarily a lawyer and I study bond contracts. That said, I’m happy to talk about all sorts of topics that nobody responsible should pay attention to, like economics and politics. So –

Alexei Monsarrat: (overlapping) And, Mitu, that’s a good point to just briefly interrupt you, and I should have said at the outset that this call is on the record. So, anything that you say that no one will want to associate with can be printed.

Mitu Gulati: Wonderful! So, let me start with the position that many of my friends in the official sector take, which is that Greece is unique and there’s really nothing to be learned from there. That we should put it to the side and everything is good now. So, I had titled my talk, “Greek Lessons,” and that’s the farthest thing from my mind, that Greece is unique. So, lesson one is really whether we learned anything from the delay. So, let’s go back to April, 2010. And in April, 2010, what did we have? Well, we had the precise legal strategy that was used eventually in March, 2012, but we also had a very large Greek debt stock that was almost all in the form of bonds and almost all held by institutional investors, meaning a restructuring could have been done, especially given what we know now about what happened in late February and early March, 2012, could have been done very easily at that point. How much would it have taken to get us a sustained debt relief? About a 30 percent cut from the private creditors at that point. The question then is, whether the cut to the private creditors took now, and the position Greece is in now, is a better or worse one than we would have been in two years ago if we had done the same thing there. Now, I think it’s fairly clear that two years ago, if we had done what we did today and we didn’t learn anything in the intervening two years, at least in terms of legal strategy that helped us do the deal any better this time around. Now, maybe there are other things that people will say happened that helped us do it better, but as I calculate, the positions of pretty much everybody in the game, the official sector, the creditors, and most important, the Greek government and the Greek people themselves, all of them were worse off as a result of waiting for two years. Now, enough crying over the Greek situation. The question is: Well, does this teach us anything now for what we should do? Well, the one thing we know as a legal matter is that creditors for other Euro Zone countries who hold local law bonds should have the fear of God in them, because now they’ve seen how incredibly easy it is to restructure their local law bonds. And going back to Greece, the technique that Greece used vis á vis the local law bonds is actually a fairly gentle technique. It could have been done much more brutally using other aspects of local law. What do we know about the other Euro Zone countries? We know that over 95 percent of the debt of most of the Euro Zone countries that are in danger, is in local law bonds, that means enormous debt relief is waiting around the corner. But should you take the debt relief? And I think here is probably where Anna and I disagree. If I take what my official sector friends tell me, which is that Greece is unique, Greece is over, we never want to see that kind of situation. Again, what can we do? Well, we could try to do something much gentler, which is to go to the creditors who, as I said before, should have the fear of God in them and say, “Look, you have these crappy local law bonds. We’re willing to give you a swap. Look at Greece and look at how difficult it has been for Greece to restructure their foreign law bonds.” Now, the caveat here is that those foreign law bonds are being restructured at meetings right now over the next couple weeks. I think the dates have been postponed until April 4, but the meetings are scheduled for right now. But if we take for granted that those are much more difficult to restructure, there should be a big incentive for people to exchange the local law bonds for nice, heavily contracted foreign law bonds. How much would they be willing to exchange for? Maybe 20 to 30 percent of a haircut. Now, the question for me then is: Is that enough to get these countries significant relief and get out of the burden of having to constantly do more austerity that really doesn’t seem to be taking them anywhere? All right, Anna, it’s yours.

Anna Gelpern: Oh! Well, thank you, Alexei, and thank you, Mitu, and thank you to all assembled [Inaudible 00:08:42]. The interesting question about Mitu’s remarks to me is: To what extent does the ingenious legal technology that he described, and I actually do think that it is ingenious and I recommend his paper with Jermaine Settlemeyer to all assembled; to what extent does it determine the outcome? And to what extent should it determine the outcome? And I’ve been repeating this three-part analytical framework kind of over and over in a very boring fashion over the past couple of years. In order for a sovereign restructuring to work, the three dimensions have to align; the political, the economic, and the legal. And I am absolutely persuaded that Mitu can make the legal dimension work. It is the political and economic, and which by the way I have no competence, that gives me pause. So, what have we learned from Greece on the politics? The first unusual aspect of the Greek restructuring is the uncertainty about who makes the decisions and how. In the olden days, debt restructuring was negotiated or decreed by some combination of the debtor and the creditor. The official sector would come in, but this was a fairly simple intervention. Here Greece had no agency from the start, right? So, the decision to restructure or not to restructure that could have been made in April, 2010 was not and, probably given the politics, could not have been made by Greece, right? So, to the extent we’re now talking about a restructuring by Portugal and Spain, Ireland, or Italy, who decides to pull the trigger is a crucial question to which I don’t think we have an answer. This is related to the challenge of the emerging European, sort of, crisis management architecture that ESM pulled the political architecture of ESM, and the persistent collective action problems within the Euro Zone, right? So the collective action problem, which everyone expected to be among private creditors, in fact, took place in a very colorful fashion among the would-be guarantors of the debtor. So, Finland demanding collateral for its participation is, to me, the most startling example of this collective action problem, where any one of the Euro Zone guarantors can potentially hold the decision hostage to their domestic political priorities. Related is the Troika dynamics, right? Again, in the olden days, there was the IMF program, there was the IMF financing envelope, and there was periodic tension over the next IMF review, but that was something that was relatively predictable compared to the 17 to 27 part collective action circus that unfolds with every European disbursement. And I think that hasn’t gone away. So, the politics of the decision-making about restructuring I think is very much up in the air and I think that, more than any legal technology, is likely to determine the outcome. Second, economics. The first Greek debt sustainability analysis didn’t look nearly as tragic as the last. Now, Portugal, Ireland, Italy debt sustainability analyses look very similar, so how do we know that Portugal is next and not Ireland and not Italy? Well, there’s some very good arguments to why that might be, but, frankly, how do we know that this is the DFA to trust? That is the debt sustainability analysis to trust? And that in turn would determine the terms of the kind of preemptive voluntary swap that Mitu is advocating, right? How much debt relief is enough very much depends on your view of the debt sustainability profile, and how do we know which one to trust? Moreover, if, in fact, all of these countries have more or less the same sustainability profiles, can Europe and the world handle three restructurings? Is there a firewall and what’s the possible contagion scenario? Next, and Mitu referred to this when he talked about the evolving composition of Greek debt, the increasing role of the official sector, the entry of new official actors, I’m mostly focusing on the European Central Bank, and the relative treatment of different creditors in the alternate restructuring is critical here, right? So, now we know that the ECB will not participate in their restructuring. We probably know that Euro Zone financing might be extended or the rates might be lowered under the table, but we’re not going to have the sort of official sector involvement, as people now like to call it, that we have, let’s say, in the Paris Club, right? So, there’s a lot of murk about the economics of various creditor groups involved and without having a better grip on that, I don’t think we can make an intelligent decision about the terms of a restructuring today. Finally, and most briefly, since Mitu addressed this, the law. What is the relevance of existing institutional and contractual equipment for debt restructuring? So, we have the emerging legal architecture of the European stability mechanism and, on the one hand, the commitment to have collective action clauses and, on the other hand, the sort of increasing wobbliness of the commitment to involve the private sector. What does it mean? I don’t know. Should the treaty be ratified? What will be effective, tax and private sector involvement, in the treaty be effective? Again, interesting question mark. Finally, on the famous collective action clauses, right now we seem to have emerged with three flavors. The olden day CACs of the sort that Greece has in its English law documentation, bond by bond, occasionally with aggregation cross-references, are a majority of restructuring provisions. Then we have Euro CACs; these are the clauses that all European countries committed to put in their domestic law debt effective 2013 or maybe later in conjunction with the ESM. And then we have the retro CACs, which Greek refused, and that is the retroactive legislation that imposes majority amendment provisions on the existing debt stock. At a minimum, I wonder to what extent anybody should care about the Euro CACs in domestic law debt if, in fact, having debt under domestic law means the capacity to do whatever you want retroactively whenever you need to do it. And with that, the remaining question is then: Well, why would you surrender that flexibility today for the rather unscientifically determined 20 to 30 percent when you might need it a couple of years from now to get 75 percent or perhaps not use it all? There we go.

Alexei Monsarrat: Thanks very much to both of you. You put out a lot of really interesting issues that I hope our callers will take up with you. So, at this point, I’ll turn it back over to our Operator to, again, explain the dial-in process. And while our call queue is building up, I’ll go ahead and lead off with one or two initial questions.

Operator: Ladies and gentlemen, at this time we are opening the lines for your questions. If you would like to ask a question, you may do so now by pressing the “star” key followed by the “one” key on your Touchtone phone now. Questions will be taken in the order in which they are received. Please be sure to introduce yourself when asking a question. If at any time you would like to remove yourself from the questioning queue, press “star two.”

Alexei Monsarrat: Okay, great. And so while things are loading up, I want to go a little bit, sort of, to the political, at first anyway, and, Mitu, you used an interesting phrase in how you were talking about the way these things could help other countries resolve their issues; one of which was “lightening the burden of austerity on these countries.” If I were, say, a Northern European country with a lot of money and a powerful export sector, I might say that actually it’s the burden of austerity is what’s going to really make you do what you need to do and that without that you have a moral hazard problem and these sorts of things. And so I’m just sort of curious what your thoughts about that is and as well as what that might mean for a place like Italy who some might say Mario Monti might not be there right now if it hadn’t been for some of the austerity.

Mitu Gulati: So, I think, Alexei, you brought up a really interesting question, and here’s my sort of quasi-political science answer to it. I am not completely sure. I think one thing we know is that it’s not at all clear that the current austerity measures are getting any of these countries back onto a high growth path. I mean, they weren’t on a high growth path in the first place and the current austerity measures don’t seem to be getting there. So, then we have to ask the question of: Whether or not this austerity is achieving other goals other than growth? And I think that there’s a good, or at least, a plausible scenario in which we’re doing austerity for the wrong reasons, which is that politically the politicians in the richer countries have to be able to justify their providing funds to their own citizens by saying, “Look, you’re suffering pain by having to provide these funds through your tax Euros and so, therefore, the others who are receiving it, will also suffer some pain.” I don’t really see this. I think if the creditors were the ones providing the funds, they would be just trying to figure out how to get higher growth rather than impose pain. So, for me, the demands for austerity come from political imperatives and are rather depressing.

Alexei Monsarrat: Okay. Thanks. I will now turn to Howard Schneider from the Washington Post.

Howard Schneider: Hi, you’all, and thanks for doing this. I just wondered if anybody had thoughts, you sort of raised both the political and economics dimensions of this, Anna, whether you think the sort of emerging architecture of the ESM, EFSF, is lining up economically and politically to avoid any more restructuring? Or whether you think that the temptation for Portugal or Ireland or any of the others is going to prove too much now that Greece has opened the door?

Anna Gelpern: My sense is that, and I think Mitu might have a lot more sense, is that what we saw while elegant in its own way is hardly tempting. I think that the entire meme of kind of tempting sovereign restructuring is somewhat misguided. This is phenomenally painful for all involved and so if anything what I might forecast is excessive aversion to private sector involvement going forward or excessive is maybe too judgmental. So, I think, given Greece, other countries and their European guarantors might say, “No PSI, no, no never mind,” especially given the emerging architecture of the ESM, EFSF, which cannot credibly claim to have the capacity to support Greek style operations in all of the countries you mentioned. I mean, if it’s just about – Greece is unique and Portugal is unique, but after Portugal, you’re out of money. So, I think you might be unique by default, because you just don’t have any more cash in the till. And I think that in turn feeds aversion to restructuring. So, if Mitu could engineer attempting restructuring, then I think we have a light at the end of the tunnel, but so far nothing is tempting.

Howard Schneider: Thank you.

Alexei Monsarrat: Mitu, I don’t know if you want to jump in.

Mitu Gulati: I mean, I agree with Anna completely. None of these solutions are tempting. The fact that the Greek deal was done so quickly and with what now in hindsight looks to be tremendous ease, that doesn’t mean that there wasn’t enormous pain and that pain is continuing, unfortunately. But I think that in calculating what’s going to happen in the future, I think we have to think about the fact that regardless of how much of a firewall is put up and how much money and structure is put into all of these new mechanisms in the Euro Zone, that the calculation is being made in multiple capitals right now as to whether or not to dote on the path of delay, as Greece did, and basically shift private sector funding for official sector funding; that’s exactly what is happening in Portugal, or to do the restructuring now. And I think we are all assuming that the official sector does not want a private sector restructuring, but I think that minds in the official sector think that what’s happened in Greece where basically the official sector is now the primary lender to Greece and Portugal; that’s a terrible thing. This is the situation that the Euro Zone governments did not want to be in, and I don’t think they want to be in it again.

Alexei Monsarrat: Uh-huh, great. Thanks very much. We’ve got John O’Conner from J.H. Whitney Investment Management.

John O’Conner: Good morning, everyone, and thank you very much for your comments. If I could ask you to just expand a little bit on two things that did not come up. One is the discussion that, what was very beneficial, I believe, in this chapter was at least some precedent setting about CDS. The second thing is: Could you comment on the implied subordination of private creditors to public sector creditors holding what were thought to be identical instruments? Because now we have three factors which would serve as the precedent for future restructurings, which the simple physics of the equation suggests will be forthcoming. One is, if you’re a private holder, you’re subordinate to a public holder regardless of the identity of the instrument. Secondly, retrospective collective action clauses work, and the market is beginning to price these things. And then thirdly, the CDS do kick in. Would you agree that these are three precedents that are now established and will form the lens through which future restructurings will be viewed?

Alexei Monsarrat: Mitu, do you want to go ahead and answer that one?

Mitu Gulati: Anna, if Anna would take it first out, I’ll take it.

Anna Gelpern: So, I would take your framing with a couple of tweaks. I think that what we know for sure is that central banks will not take a haircut for now. At least they will not take the haircut – they will not take the haircut; although, the debt they hold might somehow, somewhere be restructured, but that’s unsaid at the moment, right? I don’t think you can extend that to the entire public sector. The Europeans have been stretching out the maturities, lowering the interest rates, and we haven’t seen the end of that. But that’s very consistent with Paris Club precedent and it’s just not in the Paris Club. Retro CACs work, you betcha, right? And which again brings me to the question of why is Europe investing time and energy into finessing its domestic law documentation, which I think is generally a healthy exercise, but if, in fact the plan, or not the plan, but if, in fact, there’s always an option of going the route of retro CACs, I think that investors should heavily discount any particular features of domestic debt documentation. CDS, they do pay, but I think that’s about all you can say about that. I think the disconcerting thing about the CDS sub-story in the Greek saga is just how much uncertainty there has been and continues to be about exactly how they are made to work, and my sense is that it’s all being made to work with a lot of Scotch tape at the moment, and there’s still questions about settlement and there’s still questions about liquidity in the new Greek debt market because of some of the hold over CDS issues. So, I think that CDS are not dead, but they’re not exactly a-okay.

Mitu Gulati: So, I mean, I agree with everything that Anna said. There’s just a couple more things to add. So, on the private holders being subordinated, I would not take that to the bank. I think that what happened with ECB swap this time was really unusual. I think it was probably fought hard and that the ECB finally won out, making claims that this just had to happen, but I don’t think it will happen easily the next time around. I think what we’ve seen was basically a mistake for the ECB to be buying all these bonds without telling the market ahead of time that they thought they would have priority after the fact. And I don’t think that if you look at the constructure of the Greek debt stock and you’re expecting a restructuring, that it’s plausible to think that the official sector will have priority. If that actually happens, then the official sector will have to get cut and that’s just the reality of how the debt stock is currently arranged. And as for the CDS’, yes, they finally got paid, but they got paid because the deal didn’t go the way it was supposed to go. If the deal had gone the way the official sector wanted it to go, which was much more of a voluntary restructuring, the CDS holders would not have been paid. And if I were a CDS holder, I would be very scared about what has just happened with Greece, which is the whole process from beginning to end seemed like it was screwed up and, yes, they got paid in the end, but it was almost by mistake.

Anna Gelpern: Just one more note on priority, I think Mitu is exactly right and this bears emphasis. There’s the old saying that when a pig becomes a hog, it gets slaughtered, right? It is insane to rely on any particular characteristic of any legal instruments for priority, right? In the late ’90’s, there was this view that bonds were somehow senior. Well, they were or they weren’t, right? So, when money needs to be had, it’s taken from the deepest pocket, and I think this will affect how central banks intervene. I mean, even in the multi-lateral losses on poor country debt, right, except they did it through trust funds so they didn’t do it directly. So, I would agree with Mitu entirely. Don’t take it to the bank and, if it’s a hog, it’ll be slaughtered.

Alexei Monsarrat: Okay. Thanks.

John O’Conner: Thank you.

Alexei Monsarrat: Okay. We have now got Clay Lowery at Rock Creek Global Advisors.

Clay Lowery: Thank you. I thought it was an interesting premise. Mitu, when you started, I thought you were actually just cheerleading the idea doing restructurings and that it’s almost like a panacea, right? As I listened to you further, I don’t think that’s where you are. But I was trying to figure out if it goes back to an argument, obviously that was going on around 10 years ago that died, and I think rightfully died, but that doesn’t mean it shouldn’t come back, is that whether or not does the international policy community need to start thinking through; you remember the whole FDRM debate, whether or not we need a global mechanism to try to deal with these type of issues, or is it better to just do it the way it’s being done, which is kind of case by case, which obviously is going to create its own set of market consequences because of sort of the incentives that both of you have kind of pointed out have come about through this restructuring. So, I guess my main question is: Do you see any appetite for people trying to think through more systematic solutions? Or is it just, let’s continue to do the case by case approach where the official sector will throw up a lot of rhetoric about how we never want to do this, and then in one actually hits the fan, you do do it. So, that’s my question.

Mitu Gulati: Well, I mean, I think, Anna and I were talking about this just this morning, and I think we both agree; although, we probably, from different perspectives, that what we’ve seen makes a strong case for a systematic mechanism. The question is: What do you want out of the systematic mechanism? So, traditionally, every time you have a disastrous restructuring, one that drags on for years and everybody’s unhappy at the end of it, people complain a lot about hold-out creditors and the delays that they cause. Now, that’s, I mean, for the economists on the line, that should just be loony, because you think, “Well, that’s such an ex post perspective.” If you take an ex ante perspective and you think, “Look, I want to have this system to work effectively,” you should have two things. One is: At the front end you need to give creditors a better mechanism to be able to sue effectively. Now, that’s what we would think if it was private debt. You need to have an enforcement mechanism that actually works. And then at the back end, you need to have a system that protects against hold-outs. And now, for some reason, neither the creditors nor the debtors in this world for now over a century, have been willing to move to that system, and I don’t understand the dynamics of that. But us academics talking about how in a perfect world it would be rational to move them more systematic mechanism has no value if the sentiment is so strong on the private side that no, the ad hoc system where we just do solution by solution and work it out with side deals and backroom is the better solution.

Anna Gelpern: And again, ditto, ditto, ditto. The thing that is striking to me in this go-round with the domestic debt and the Euro CACs and the retro CACs is that the creditors and, by the way, everything that is going on with Argentina at the moment. I mean, 10 years later, we’re still talking about Argentina and we’re still sort of looking for pennies on the ground. And the creditors seem to have lost a number of rounds by some metrics. And so if, in fact, we think that the contracts don’t protect creditors, well, golly, the creditors should be clamoring for stronger enforcement and/or orderly restructuring. It’s probably a political economy problem. It’s not a private creditor collective action problem at the moment.

Alexei Monsarrat: Okay. Thanks. And we’ve got Dean Andromidas from Strategic Alert.

Dean Andromidas: Yes. Good morning. I’ve been following the Greek situation, well, all along, since 2010, and I just want to refer to the category that Anna Gelpern referred to; political, economic, and legal. Politically, the situation in Greece, this whole policy is clearly unsustainable. To give you an example, this weekend on Sunday was Greek Independence Day. So, of course, they have a parade; all the politicians come out, they stand on a podium in front of the Parliament. If you’ve ever been to Athens, there’s a big square called, “Syntagma Square,” and usually tens of thousands of people gather in the square to enjoy the parade. This time the politicians were so terrified of the population that they called out 4,000 police. They forbid any citizen without a written invitation to stand anywhere near the podium. The whole Syntagma Square was considered, was off limits for anyone without an invitation. There were more policemen. There were 4,000 policemen; that was more than the people marching in the parade, and this was a student parade, and the students, as they marched past the dais, they faced the other way in protest. And in other cities, you had demonstrations, clashes with the police, and, of course, this we have seen, particularly for the last year.

Alexei Monsarrat: I wanted to make sure there was a question.

Dean Andromidas: Oh, there’s a question. I’m asking on that question: Have people considered this the political sustainability of the policy? I guess, my first question. The second question is economics. The Greek economy is in freefall. The austerity can’t keep up with the collapse of the economy and that’s collapsing the revenue. 30 percent of the population is basically, of the electorate, is basically unemployed. The horror stories of what is happening there is quite unbelievable. Also, on the financial side, the whole motivation of the EU in this whole process with Greece has not been to save Greece by any means, but to save the financial institutions in the various countries, particularly France and Germany, which held a tremendous amount of this debt. And that also goes for Ireland and Portugal, whatnot. Ireland is a case in point where the debt crisis there has nothing to do with the actual balance of payments of the budget or anything like that, but the fact that they took on –

Alexei Monsarrat: (overlapping) The political and economic issues, Anna, do you want to jump in since these were your three categories? And then, Mitu, you can jump in as well.

Anna Gelpern: I just put them out there. So, there’s, someone referred to the physics of this. I totally accepting your characterization of the political and economic unsustainability of the situation. I think, being that we’re technicians, so what do we do about this? You either get the money from somewhere outside Greece, in which case you’re running into a different set of political and economic factors; this time in Northern Europe and other surplus countries, or you get out of the Euro, the Euro Zone, and Europe, right? And that is a judgment about contagion and the effects of changing currency regimes in Greece and beyond Greece; certainly I’m not equipped to make. But if you think that the benefits of being able to float are higher than toughing it out, then absolutely, right? But these are not – in a really frustrating way, none of this is rocket science, right? If Greece cannot adjust politically and economically, which I have no competence in judging, but I’m buying completely for the moment, right, then money has got to come from somewhere, and it either comes from another political space, which is also challenging, or from an exit, which is challenging in a different way. And that’s where I hit my wall of competence completely.

Alexei Monsarrat: Okay. Mitu, I don’t know if you want to –

Mitu Gulati: (overlapping) No, Anna said all that needed to be said.

Alexei Monsarrat: Okay, great. We’ve got Ben Carliner.

Ben Carliner: Thanks very much. I’d like to bring this back to the issue of the massive increase in the official sector’s holding of Greek debt in the wake of this restructuring. And I’d like to ask whether the speakers think that this might point to a way forward in terms of both future restructuring down the line for Greece and possibly for the other countries as well, given two key things. The first is that the official sector holdings of all this Greek debt and all their restructuring, which just happened, seems to take much of the risk of financial sector contagion off the table, at least for the short term. And secondly, in that, is it possible that this could be the way that there could be a back door fiscal transfer from core Europe to the periphery in the sense that politicians in core Europe cannot justify writing checks to Greece, Portugal, Spain, their constituents, because it just seems like a bail-out. But maybe it would be easier for them to sell a fiscal transfer in the form of debt relief, given that they could sell it as being necessary to save EU, Euro Zone institutions, and so that’s my question.

Mitu Gulati; You know, I don’t know. What you described is certainly accurate vis a vis what is happening right now. I think that the political incentives that you describe are exactly right as things stand, but the history of sovereign debt would suggest that official sector lending, especially when you have countries at risk of basically becoming wards of the official sector, just hasn’t worked out very well. And maybe this is just my belief in market discipline, but I think private creditors, even though they have less power to arm twist, ask for the right things, which is they want the country to do the things that will enable them to get paid back. Whereas, if you go into a world of this largely official sector lending and support so that you can make transfers without anybody realizing it, then we’ve seen some history that the official sector asks for all sorts of either implausible or inappropriate things that don’t really help the country in question. So, I think you are right that we seem to be going in that direction, but I don’t think it’s a good thing or a thing that we should want.

Anna Gelpern: Totally agree. I think that in the following sense: Yes, having official debt gives an opening for all kinds of public accounting arbitrage, if you will, and the government lenders can evergreen as good as anybody. So, you can roll it, you can reschedule it, you can rejigger the accounting treatment without telling the voters. And that has a time-honored history. However, the next question; this is what Mitu was going into, very much depends on whether this is a path to fiscal union or another kind of first world, third world, more ongoing relationship; albeit, not a very savory one, right? So, is this about European creditors lording over impoverished African debtors? Or is it about negotiating the terms of just fiscal transfers and buying time for the public in Europe to come to terms with the fact that this is, in fact, a fiscal union because the exit option has been foreclosed and it’s just a question of how we get from here to there at which point market discipline of the sort Mitu described, it’s not really the alternative to fiscal transfer. First, you have to decide the terms of the fiscal union and how much the center is going to finance the periphery or vice versa and how the revenues are going to be shared and all that. And then you decide what needs to be raised from the market; how and on what conditions. So, I think the presence of, in the shadow of the fiscal union, makes this question somewhat more complicated in Greece and elsewhere in Europe than it might in previous sovereign cases.

Ben Carliner: Well, Greece has already given up some of its sovereign rights to the Troika. Has it not?

Anna Gelpern: Indeed, and the question is, again, it’s all sort of put together with Scotch tape, right? Is this temporary? Is this permanent? How is this going to be tweaked? Does ESM evolve? Does the fiscal compact evolve? All of this is part of the calculus.

Ben Carliner: Right. Thank you.

Alexei Monsarrat: Thanks very much. Now, we turn to Jack Boorman.

Jack Boorman: Hi. Good morning. I want to make two very quick comments, if I may, and then ask a question. I think we need to be a bit careful about what we think we’re learning from the way in which Greece was handled and whether or not it’s repeatable. There was just unbelievable political force. There was obviously difference of view amongst the different parties and different governments in the EU, but there was unbelievable political force to get something done in this case. Whether that’s repeatable, and especially beyond Europe, as a mechanism for dealing with these kinds of situations, I would be very skeptical of. Secondly, the comments about the austerity in Greece and the rest of it are well taken. I agree with them completely. We shouldn’t forget, though, that the degree of austerity that has been required is a function of the fact that that situation was not dealt with early on. As in Latin America in the 1980’s, that delay has been very costly. My question is the following: Should we not be more concerned about the retroactive insertion of collective action clauses or other changes in the law and in bond contracts? It seems to me there’s a very important question about the rule of law and the confidence that creditors, markets, and others can put into the environment that they think they’re operating in when government somewhat cavalierly simply changes the rules of the game. Thank you.

Mitu Gulati: Anna, you want to go first?

Anna Gelpern: Sure. And Mr. Boorman is deeper on this than most of us, certainly myself. But I do pause at the invocation of rule of law, which you see a lot these days, and there’s these inflections of rule of law outrage. Part of the legal landscape of sovereign debt is sovereign immunity and the difficulty of enforcement in sovereign debt and with domestic law debt, the added difficulty of litigating, right? Whether Greece’s use of the leverage it had all along and that every sovereign has is a surprise to the market, is to me distinct from the question of whether it’s somehow a violation of any law, legal principle, or international norm. I mean, golly, Russia paid its domestic law creditors five cents on the dollar into a locked account, right? Domestic debt has always been a bit of a free for all, and the fact that most of global sovereign debt is governed by domestic law and, in fact, an owed by rich countries is something that investors should think about. If, in fact, we are concerned about retro CACs, then I think that we should think about changes in the current international regime for both sovereign immunity and debt restructuring, just something that Mitu referred to just a few questions ago. But I’m not convinced –

Mitu Gulati: (overlapping) People are talking about this a lot, but, again, if we look back, sovereign debt, and look back at what lessons we’ve learned over the past couple of centuries from sovereign debt is, and private creditors have learned this certainly in the emerging markets, which is that you lend to a country under its own law and in its own currency, then you’re taking much more risk than if you lend to a country in a foreign currency and under foreign law and then add in to that the impact of different contractual protections; all of that should be adequately priced. Now, I think it’s fairly clear that in the case of the Euro Zone, what we saw over the last 10 years was that after the halo effect of joining the Euro Zone, a lot of these countries were basically able to issue large amounts of debt of foreign investors under local instruments, the kinds of instruments that foreign investors previously were not willing to buy. So, if we go back and look at the little pricing data that we have available, you see a sliver of difference between the foreign law bonds that were still being issued because there were some investors, some large institutional investors in places like the U.S. and the U.K. who still would not buy the local law bonds and then you see the price on the local law bonds, which was giving you a small yield benefit that was largely lapped up by Euro Zone banks. And they were willing to take that risk, but I think they recognized that risk, and then the risk materialized. So, it’s hard for me to see this as any kind of rule of law violation, and the way you see this is people think that the retroactive collective action clauses, oh you’re putting in contractual privileges retroactively would be such a terrible thing, but the local law benefit could have been used in a much more brutal way. So, just a couple of things that could have been done. Most of these local law contracts did not have a restriction on the country just taxing the bond, but again that tax gross up clause that it would be irresponsible to lend to some emerging market without a tax gross up clause, which doesn’t allow you to tax them on the way out. They didn’t have them; that could have been done. They didn’t really have, for the most part, negative pledge clauses, so collateral could have been given to them to change their priority. You could have changed the local laws to make it much harder to sue, because they didn’t really have mechanisms to sue outside. Most of them didn’t have sovereign immunity protection. So, again, I think part of the idea with the collective action clauses was to give creditors something of a voice in the actual decision at the end and to make it more gentle than it could have been done. But if I were doing it on my own and the country were actually able to ask for as much relief as it wanted, collective action clauses might not have been at the top of the list as a mechanism to get maximum debt relief.

Alexei Monsarrat: Okay. Thanks very much. What I’d like to try to do, Operator, if we can, we have two calls and we’re pretty close to time, so I just thought maybe if we can collect them both and then go from there. First, we have Arturo Porzecanski, and then John O’Conner.

Arturo Porzecanski: Hi. Thank you very much for your observations. Just a few comments that haven’t been mentioned. Yes, of course, everything would have been easier, cheaper, faster two years ago than now, but that’s just not how it works precisely because of economics and politics. It’s like saying when everybody gets married, they should sign a pre-nuptial. It’s a lot cheaper, faster, and everything that goes into a divorce, but most of us don’t because we believe in love and other things like that. So, it’s not all about contracts. The other related thing, some things that haven’t been mentioned; most of the creditors of Greece are European banks and insurers who are under the sum of the respective government regulators and they would have gone along with anything that was put forth, because they are so dependent on ECB funding and, in general, on the whole regulatory thing. So, I wouldn’t give a lot of credit to the retroactive application of the CACs and to other legal features. They would have signed anything. Maybe the participation rate overall would have been in the high 80’s or low 90’s as opposed to in the mid or late 90’s, but it would have been an over subscribed deal no matter what was put in front of them, because this was not a voluntary deal. Another thing is one of the reasons why it wasn’t done a couple years ago was because at that time there still was a demand for Greek bonds. It was a possibility to fund yourself out of the problem with a little help from your friends in Berlin, Washington, and elsewhere, but what occurred along the way, starting in October, 2010, is that Berlin and others in particular killed the Greek bond market, killed the demand for bonds, and then when there is no demand for your bonds, then you enter into a restructuring scenario. But everything that happened, starting in the real France and after, in terms of the demands that the private sector participated and sacrificed and so on and so forth, who could have said that that could have happened? But that was one of the key things and that’s why politics and economics are so important. Thank you very much.

Alexei Monsarrat: Thanks very much. And why don’t we go ahead and hear from John now?

John O’Conner: Thank you very much. I just was wondering if either or both of you would want to compare and contrast Iceland and Greece, having had two sort of full cycle experiments now. Who’s better off?

Alexei Monsarrat: Great question. Who wants to jump on that? Mitu, you keep deferring to Anna, so I’m going to pin you and make you –

Mitu Gulati: (overlapping) Woo hoo! I mean, you look at Iceland. You asked a tough question. I mean, I think that if we ask people in Iceland and Anna and I were both in Iceland actually ironically for a sovereign debt restructuring conference that primarily focused on Greece, so it’s relatively recent. I don’t think people there think that they have recovered at all, because their financial structure was completely destroyed. But if you look at their credit rating and their ability to borrow on the international markets, they’re doing pretty well, but it’s hard to separate the two because I think that Iceland has actually benefited enormously from the Euro Zone crisis. It’s taken all of the attention away from Iceland being a misbehaving party and put it on the Euro Zone countries, which are being portrayed as having misbehaved far more, and Iceland looks quite good. But that said, I mean, it’s just not separable for me, given how very, very different the situations are. But I realize now I haven’t really given an answer to your question, so my apologies.

Anna Gelpern: I’m going to give another non-answer, which is that Iceland has a currency and Iceland put in capital controls. So, I sort of think that our starting points are so different and the story of Greece is the story of a currency union and the politics of a currency union where all the relevant actors are not including the people in the north and the south and east and west are not on the same page about what it means. Compared to that, Iceland is a piece of cake, but as Mitu just said, it’s kind of boring that we all agree, isn’t it? But I don’t think they think of themselves as having lucked out and I don’t think you can blame them. So, there is no Disney World sovereign debt restructuring, alas.

Alexei Monsarrat: Okay. Not a bad note to end on; if not especially rosy. But I want to thank Anna and Mitu. It’s been great. This has been a really great conversation and to all of our colleagues, and we will be back on the line before too much longer, so keep an eye out. And I hope everyone has a good day. Thanks very much.

Mitu Gulati: Thank you.

Anna Gelpern: Thank you.

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