If you are interested in the frontier thinking of European debt restructuring, you need to read the latest from Buchheit, Gulati, and Tirado. In it, they propose an amendment to the European Stability Mechanism (ESM) that would make future European restructurings easier by strictly limiting the rights of holdout creditors. It’s designed with an eye to the smaller countries of Europe, which have significant debt issued under foreign law. With the prospect of a restructuring in Cyprus on the horizon, and concerns about debt sustainability across the periphery, it’s a timely proposal. While a treaty change seems far fetched, some European policymakers will find it appealing. That doesn’t mean it’s good policy.
I have earlier written on the revival of support for a Sovereign Debt Restructuring Mechanism (SDRM) and this proposal would create a SDRM-like mechanism, within Europe, for European sovereign debtors. In the Buchheit et.al. plan, if a country was adhering to an ESM-supported program, their assets would not be subject to attachment in the ESM-member country. Thus it creates a safe harbor in Europe from holdout creditors seeking to enforce judgments obtained abroad. The idea is modeled after the 2003 restructuring of Iraq’s debt, where a UN resolution protected Iraq’s oil assets against attachment in UN-member states.
The appeal from a policy perspective is obvious: it ensures that when a country is receiving extraordinary support from its European partners and restructures its debt, that money isn’t going to holdouts. By making restructurings easier, it gives policymakers confidence that the necessary financial objectives set out by the Troika (the International Monetary Fund, European Central Bank and European Commission) will be achieved. And while the official European position is that the Greece restructuring was a unique event, debt is unsustainable across the periphery and a full bailout by the core looks neither economically nor politically feasible. Restructurings will be needed.
A few cautions to keep in mind, though:
The protections only exist while the country owes the ESM money. In that sense, it’s a rule to protect creditor countries rather than the debtor. Further, the protective shield created here covers transactions only within the euro area. For a European bank with operations in New York, for example, it is unclear how their assets and operations would be protected from U.S. court judgments. The upcoming U.S. Appeals Court ruling on claims against Argentina will go some way to answering that question.
Part of the appeal of this plan comes from the ongoing mess in Argentina. The analogy for Argentina, had the SDRM been created, would have been protection from creditor judgment as long as it owed money to the IMF. Sadly for this analogy, Argentina repaid the IMF long ago, so they wouldn’t have been covered. The broader question, though, is whether a country that abandons its adjustment effort and aggressively refuses to negotiate with its creditors should continue to receive protection.
Creditors will understand the intent of the law–to make restructurings easier and more successful. Further, as Greece showed, its tempting to squeeze private creditors for that last euro of financing when official creditors are deadlocked. So the innovation will make debt more expensive, much as an emerging market country pays a premium to issue locally (the problem of “original sin”). The cost much of the time will not be great–certainly we see that during periods of easy credit availability, domestic versus foreign-law spreads can be quite narrow–but will be high during periods of stress, when market access is most valuable.
More generally, most of the major debtors of Europe have majority local-law debt, where such a rule is not needed to reschedule. Where foreign-law debt is significant, market-based exchanges backed by moral suasion from governments should be able to limit holdouts. In this sense, the problem for Europe is the unwillingness to approach debt sustainability in a comprehensive fashion, rather than threats from holdouts.