Michael Dooley Chief Economist and Partner, Cabezon Investment Group Prepared for GIC Conference “Re-Examining Central Bank

Orthodoxy for Unorthodox Times” Paris, March 26-27 2012

Sovereign Debt Restructuring: Issues that Shape the Negotiation Official and private creditors have very different

interests.

Official creditors concerned with international markets’ stability and political stability of debtor.

Private creditors usually want out.

The loss to be shared is quantified by a debt dynamics model.

Sets out not just the path for debt but the distribution between private and official.

The distribution of the expected loss depends on bargaining power.

Official creditors “buy out” private creditors.

Haircuts for cash.

Greek exchange € 15 cash for € 65 Greek risk.

Official creditors provide new credits.

But for how long?

How to establish buyback price?

This is pure bargaining power there is no “right” answer.

Who has the power? In 1980s Brady deals the private sector was powerful because the US government took the term “voluntary” seriously.

Does Contract Design (CACs) Matter?

Within private sector? Yes

Between private and official? Not clear.

Lessons from Greek exchange

• For several years now it has been generally known that for a default supported by the IMF and governments CACs could be inserted ex post.

In Greek deal two things changed.

First, Europeans gave up on voluntary a year ago.

This gave the IMF the green light for a more honest estimate of the capacity to pay for Greece.

Honest in this case means more aggressive haircut.

Ex post CACs have always been available but now IMF and creditor governments sanction them.

The official sector seems to be the clear winner.

• private debt took a very large hit.

• Official holdings (ECB) not reduced.

But the Story Does Not End There The official sector used its power to punish private

creditors.

There is a price to pay.

Implicit in the latest IMF projection:

Private sector withdraws through 2016.

IMF stands pat.

Europeans exposure rises.

IMF Forecast of Greek Debt Following Exchange

Billions of Euros

Source IMF Country Report No.12/57, March, 2012

In zeal to make the debt dynamics look good the IMF and the official sector have sacrificed their ability to exit.

Very low prices for new Greek bonds suggest access to private markets is a remote hope.

Sovereign Debt Markets Looking Forward

The Greek part of the old bonds is worth less than 6 cents on the dollar worse than Bolivia in 1980!

Default remains a very costly option for the debtor.

But official creditors are likely to be much more aggressive in forcing losses on private creditors.

Elements of a restructuring.

Official cash for private sector PV contractual reductions.

Commitments for future official credit.

Assumptions about future private sector lending (return to markets)