Why the Greek recovery rate hasn’t fallen

By Felix Salmon
April 13, 2010
Peter Boone and Simon Johnson have an interesting take on the EU's bailout of Greece: that it doesn't in fact bail out Greece's bondholders at all, since any reduced probability of default is more than made up for by an increase in bondholders' loss if and when there is a default.

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Peter Boone and Simon Johnson have an interesting take on the EU’s bailout of Greece: that it doesn’t in fact bail out Greece’s bondholders at all, since any reduced probability of default is more than made up for by an increase in bondholders’ loss if and when there is a default.

The danger for private debt holders is clear: Sovereign loans invariably treated better in a restructuring than private debt. So the European aid in some sense squeezes private debt holders. They will be pleased there is no near term default, but it means their recovery value has gone down if things get bad again. Greek long term yields will probably stay high.

This doesn’t ring true to me, for a couple of reasons. Firstly, Boone and Johnson themselves were the people who said just last week that the recovery value on Greek debt would likely be just 35%. It can hardly have dropped much from there.

And secondly, it’s simply not true that sovereign loans are “invariably treated better in a restructuring than private debt”. There is a class of official-sector loans which gets what’s known as “preferred creditor status”; that includes loans from the IMF, and Greece is going to get some IMF funds. But common-or-garden loans between sovereigns — Paris Club loans, as they’re known in the trade — most certainly do not get special treatment, nor are they generally considered senior to private-sector bonds. In fact, off the top of my head I can’t think of a single instance where a country remained current on its debt to bilateral creditors while defaulting on its bonds. And most of the lending to Greece will be bilateral, rather than coming from the IMF.

In restructurings, countries will sometimes do a deal with their bilateral creditors first, and then expect their bondholders to tag along under what’s known as “comparability of treatment”. But that doesn’t mean that the bilateral creditors are treated better than their private-sector counterparts, it just means they’re treated the same. And certainly debtor nations have historically found it much easier to default on bilateral loans than to default on their bonds.

But let’s get out of the world of theory and into reality for an example: look at the US government bailout of General Motors and Chrysler. The government lost lots of money on that deal, and most emphatically was not treated better in the restructuring than private bondholders were. My guess is that if Greece ever ends up defaulting on its debt, the same is going to be true of the eurozone countries which bailed it out.

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As usual, I am impressed with your knowledge of a dizzying array of topics. But I wonder if the automaker bailout analogy is an apt one. During the auto bankruptcies, the Obama Administration was new and bent over backwards to make the auto bailout seem “fair” (and by that, I mean they wished to approximate a ‘normal’ BK process). The Administration was not wholly successful in preventing public outcry, but their intent was clear. In the case of the EU mess, I would imagine Greece’s repayment priorities are much different. Greece might find it politically expedient for the sake of their status as an EU member to honor loans made by their sovereign creditors, while they might see private credit as less forgiving/more fickle and therefore less worthy of a priority payout. The US government was the source of funds and therefore could not act as an “honest broker” through the auto BKs while also pushing for full repayment on its loans; Greece is the recipient of government funds and therefore does not have the same options or priorities as the US did.

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