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March 27, 2012

On March 27, the Global Business and Economics Program hosted a conference call with sovereign debt experts Anna Gelpern and Mitu Gulati to discuss Greece’s private debt restructuring and the possibility of other indebted Eurozone countries following in Athens’ footsteps. Anna Gelpern is a professor of law at Georgetown and American Universities, and Mitu Gulati is a professor of law at Duke University. Their analysis of what we have learned from the Greek experience, and what we should expect going forward, provided the following takeaways.

Greece’s debt restructuring could (and possibly should) have occurred much earlier. Gulati pointed out that by April 2010, the precise legal strategy for a Greek debt restructure was already in place – retroactively putting collective action clauses into sovereign bonds to force even reluctant lenders to accept heavy losses Additionally, the majority of Greece’s debt was in the form of bonds held by institutional investors, rather than individuals which would have been more difficult to track. Waiting through two years of international bailouts and severe austerity measures before eventually following this plan of action did not benefit the official sector, private creditors, or, most importantly, the Greek people.

For a debt restructure to work, political, economic, and legal dimensions must align. Despite the ingenious legal architecture that framed the Greek debt agreement, for the process to ultimately work, political and economic players must decide that a debt restructuring is the only possible solution, painful though it may be. Traditionally, creditors and debtors negotiated the terms of a debt restructuring, with some input from an official sector actor like the IMF. Now the official sector (which acts as the guarantor of the debtor) consists of 27 individual EU member-states and the Troika (the European Commission, European Central Bank, and International Monetary Fund).  Europe’s new official sector is the linchpin in the debt restructuring process, and its political complexity makes negotiations more unpredictable.

Countries are highly unlikely to rush for more debt restructuring—imposing severe losses on private creditors is certainly not an easy way out. Greece has shown that the debt restructuring process and its final outcomes are both very painful and hard to predict. Gelpern summed this point up perfectly by saying “there is no Disney World-version of sovereign debt restructuring, alas.” Greece had to agree to implement many new harsh austerity measures from its official sector guarantors. At home, politicians had to face an angry populace tired of painful fiscal austerity that has crippled the economy. Negotiating with private creditors over the specific terms of a debt restructuring was also incredibly difficult. Going forward, Europe’s financial firewall does not have the capacity to go through this process multiple times. If Portugal were to restructure its debt, for example, even the combined resources of the European Financial Stability Facility and the European Stability Mechanism would not be sufficient to prop up Italy or Spain. The promise of debt relief from a difficult restructuring does not mean much if the funds to prop up sovereigns simply are not there.

Markets remain deeply uncertain following Greece’s successful debt restructuring. Creditors have seen how easy it is for troubled states to retroactively insert collective action clauses into their domestic law bonds, which Gulati says “has put the fear of God in them.”Even more disconcerting for markets is the fact that 95 percent of Eurozone debt is in the form of local law bonds. If this process repeats itself in other states—while providing enormous debt relief to troubled economies—it would result in massive losses at European banks, the primary holders of this debt. The last thing Europe needs right now is a further tightening of its credit markets.

The event was part of the ongoing Mapping the Economic and Financial Future Speakers’ Forum co-hosted by the Atlantic Council and Deutsche Bank.