Sovereign Debt Restructuring in Europe: Lessons from Latin America

Tuesday, May 3, 2011

Experts discuss the current state of European sovereign debt restructuring, as well as the economic lessons Latin America has to offer.

This event was part of the McKinsey Executive Roundtable series in International Economics.

ROGER ALTMAN: Good morning, everybody. I'm Roger Altman, and it's my privilege to chair this very timely discussion this morning. And it's not about the history and evolution of the Navy SEALs -- (laughter) -- but instead it's about the lessons of Latin America's debt crisis and restructuring for the European sovereign debt situation which the world faces today. Before introducing the panelists, I'd just like to remind everybody on the rules.

First, this meeting is on the record. Second, please turn off your cell phones and Blackberries and all the way please. And third, when we come to questions, please identify yourself and ask a question and please don't make a speech. Let me introduce the panelists. We're quite fortunate this morning to my far right, Adam Lerrick. Adam is currently a visiting scholar at AEA -- AEI, excuse me -- in Washington.

But before that, for the past 10 years taught at the business school at Carnegie Mellon and has a deep well of experience in these issues. To his left, Ernesto Zedillo. Of course, Mr. Zedillo was president of Mexico from 1994 through 2000. He's currently a professor at Yale. He serves on a series of very large both for-profit and nonprofit boards, including Alcoa and Citigroup.

And he's been deeply involved in a whole series of commissions and efforts at assessing international economics over the past 10 years. And finally, to my immediate right, Bill Rhodes. Many people in the room of course know all these panelists but know Bill especially. Bill was -- I think it's fair to say -- the leading expert for 20 or 30 years on sovereign debt issues and among other things spent 53 years at Citigroup and its predecessor organizations responsible for -- (laughter).

WILLIAM R. RHODES: Hard to believe, Roger.

ALTMAN: Responsible for its international business and is widely seen as the leading thinker on the Latin America restructurings that we saw in the '80s and the '90s. I'd like to begin by asking each of our panelists a short question and then we'll go more directly into the topic, or the precise topic, which we have this morning.

And that short question is the following, and I'll start, Adam, with you if I may. As you see it, where does the European sovereign debt crisis stand in terms of its own evolution? Is it in its early stages? Is it rather in its late stages and how do you assess it in terms of its severity?

ADAM LERRICK: Well, first, Roger, I think the common thread among the three panelists is not only our experience in debt restructuring but is that Angel Gurria has affected all of our lives one way or another. Roger, in response to your question, the European sovereign debt restructuring, which is what's going on now, has been going on for more than a year. You've watched the negotiations are happening 24 hours a day.

They're not happening in a conference room. They're happening on the Reuters and the Bloomberg screens. Constantly the Europeans float proposals. The market reacts with prices. The Europeans adjust their proposals. That's the negotiation. What makes it even more interesting is that there's a second negotiation going on at the same time also publicly which is among the Europeans themselves. Germany says, we're going to have a debt restructuring of Greece.

The ECB says, not in a million years will we ever have a debt restructuring of the Euro area. And so you're watching two negotiations going on at once. How far along they are, that's difficult to say. It depends how long the Europeans refuse to recognize a simple fact, which is Winston Churchill once said, when you're in a hole, stop digging. And the problem is the Europeans are not stopping.

They refuse to stop digging. And until they stop digging, this crisis is going to continue. It's a very simply crisis which is that the Europeans have confused a monetary unit and a fiscal unit. And what they did in the Maastricht Treaty was basically give a performance guarantee to all bondholders saying that we will insure that every member of the Euro area will be fiscally sound. But they never enforced it.

And so the Europeans -- there are two choices for monetary -- (inaudible) -- either every government stands on its own credit, in which case the markets will set borrowing limits and enforce discipline, or the union underwrites every member in which case the union has to set the limits. The problem is that a union that cannot make up its mind is a crisis waiting to happen and that's what we're seeing in Europe. We have to wait until they decide what they're going to be.

ALTMAN: Ernesto, how would you assess it?

ERNESTO ZEDILLO: Well, I think the Europeans have been successful in what I would call the containment stage of this crisis. If we think back to the early 2010, around this time of the year, the crisis promised to be really devastating shock for the European banks and the financial system. I think they have been successful in containing the problem in Greece, in Ireland and now in Portugal.

So that's, however, only the first stage. What they have done was indispensable but probably it would not be sufficient. I think as soon as the Portuguese deal is closed and done, probably they will start thinking hard about whether the problem is one of liquidity or one of fundamental solvency. And if you look at the basic fiscal debt indicators of at least Greece and Ireland, then you will feel tempted to believe that there is a solvency issue.

And if there is a solvency issue, then at some point they will have to move into a different stage where they will have to consider seriously whether the Latin American experience is relevant. I will not be more explicit than that. (Laughter.)

ALTMAN: Bill, how do you see it?

RHODES: Well, I think that it's just a little over a year ago that people were scrambling around Europe to try and put a package together for Greece and I think they underestimated a couple of things.

They underestimated contagion, something we learned, you know, the hard way in Latin America and then again in the Asian financial crisis later on. And so we now see that we have Ireland, Portugal and people are very concerned in the EU about defending Spain. It's like La Pasionaria had said during the Spanish Civil War: ¡No pasarán! -- they shall not pass.

And so Spain in the sense in the minds of policymakers in the EU have been that that's where it's ring fenced. But each one is different. There's no cookie cutter approach. It started with a sovereign in Greece because the banks weren't in bad shape.

Obviously in Ireland you had a different situation because a government without thinking very much bailed -- started to bail out the banks and suddenly found out that their fiscal situation was undermined tremendously by the banking situation.

And I think in the case of Portugal, you have a little bit of both, although the Portuguese banks did not cause this and they have been dragged in the sovereign. And you basically don't have a government there and so the EU and the IMF are trying to deal, you know, with the two major parties or three major parties to get something going.

And frankly, I think the policymakers in the EU have kicked the can down the road because they're really not sure what they want to do. But time is running against them -- another lesson we learned in Latin America. And they really have to get moving and decide what they want to do in the sense of do they want to have a voluntary restructuring, are they prepared to give a country like Greece additional time and lower interest rates?

Because what they did a month ago was laughable. There is no way that Papandreou and his team can implement their program and they're just getting into privatizations and trying to restructure, you know, the tax system which you can't do overnight without lower interest rates and more time. The plan that the Greeks have is they wanted two years to try and get things right and then try and do it with a voluntary refinancing. But that's not going to happen under the present circumstances.

So I think the EU is running out of time -- has run out of time. And as Ernesto said, what they view as containment is going to be solvency very rapidly if they don't take some really tough decisions.

ALTMAN: Well, taking Ernesto's point and coming back to you for a moment, first, do you think that there will be defaults and secondly, how important is it to avoid them?

RHODES: Well, I think in the case of Greece, the Greeks are very much aware if they do not get better terms out of the EU and the IMF -- and remember, the IMF is a key player in here. They're equal partners with the EU and they know very well that they can't implement their program and sell it to the Greek people because there is another lesson learned.

You've got to be able to sell these programs to the people of the country and show a way out which is what the Brady Plan did, a way towards growth. If you're just going to preach austerity for the next decade, they won't buy off on it. And so I think timing is really very, very critical here, Roger. And otherwise the markets are going to force the issue on them and they're well-aware of it.

I must say, having talked with the prime minister and the minister of finance, they're very well-aware of their limitations. And so I think the issue is going to be forced over the next couple of months. There's a head of states meeting that's coming up as well as another finance meeting and they're going to have to take some -- they're going to have to take some tough decisions here because Spain has been doing much better in the sense that belatedly Zapatero started to implement some of these austerity programs.

But the consolidation of the cajas is still not complete and that is a weak spot. So they really have to move and take some decisions or, as I said, the markets going to force -- I think we're all saying the same thing and they will force a restructuring. So that's what the Greeks have put on the table.

And Ireland, as you know, a new government was elected there on the basis that they were going to get better terms. And in Portugal, we just have to see because you don't have a government. You have an interim government in there and the IMF and EU are negotiating and this government has no mandate.

ALTMAN: Well, Ernesto, let me ask you this. This point about the markets forcing a solution, we've seen that many, many times. What would that look like in this case?

ZEDILLO: Well, I would say that I don't think there will be a default. I think the Europeans know better than that because there is a lot of it at stake. It's not only that default has other consequences for debtors themselves. But I think in this case a lot of the European banking system stability is at stake. Furthermore, there is a question of the euro.

So I don't think we will get to that point of default -- of unilateral, you know, forced by the circumstances default. The other factor is that whether a sufficient medium and long-term -- I mean, there is a program in place to finance Greek debt, Greek liabilities. I think what could happen eventually if they truly confirm that this present deal is not sufficient is that we will see, as I said, the ultimate Latin American arrangement which was something like Brady Plan.

But will that happen within the next two months? I don't think so. I don't think the economic and political conditions are there. And more importantly, whatever you do for addressing the debt problem, you have to be thinking what to do with the banks.

So it's, you know, a two-pillar strategy and that implies enormous economic and political complexities. I think we have to be very careful about not forgetting how long it took between Mexico's announcement in August of '82 and Secretary Brady announcement in '89 -- seven years. I would hope that they don't take that long. I don't think our European, you know, peripheral countries can take as much pain as we took. They don't know how to suffer as much as we suffer because of these guys.

(Laughter, cross talk.)

ZEDILLO: But at some point, you know, they will have to -- I think they know about it. It's not that they are not neglecting. It's just that you have to meet certain conditions before it can be done. I mean, not until after Citibank in -- when was that -- in '87 declared that they were taking -- creating a huge reserve. It was in May of '87 and that started to trigger reactions in other banks.

I think the banking side of the equation was ready for the Brady. If you ask me today are the European banks ready and other creditors ready, I don't know. I think that is the case. In fact, I don't know who is at the end of the line, right? (Chuckles.) Who is at the end of the line? The governments, the taxpayers, bondholders? I don't think we have enough clarity to know that. But I guess somebody must be thinking hard about it, probably some people in this room, yeah?

ALTMAN: Adam, again, in the spirit of what Ernesto just said, could this muddle along at a medium boil for years?

LERRICK: Oh yes, it could muddle along for decades. The trigger -- assuming that the European Union is willing to --

ALTMAN: Well, that answer assumes that the markets would tolerate that.

RHODES: Exactly.

LERRICK: No. Well, I think it assumes something -- (inaudible). It assumes that the European Union is willing to continuously extend more credit for longer, longer terms at lower and lower interest rates. That's how it will muddle along. In the case of Greece, there's no immediate need for Greeks to finance right now.

Greece has enough money until February of next year to finance this deficit. It doesn't matter that bonds are yielding 25 percent if you don't need to go to market. Now, the one thing that could trigger something in Greece before that time, which is when the EU 110 billion (euro) loan runs out is if suddenly investors stop -- are stopped -- are no longer willing to buy the treasury bills because even though Greece is not selling bonds, they are every month auctioning off treasury bills at yields of 5 (percent), 6 (percent), 7 percent.

If that stops, then it will bring everything forward. But otherwise, it could muddle through for a long time, as long as the EU is willing to, what I call, extend and pretend and just keep rolling over. And eventually we will just transfer all the private sector debt to the official sector and if they roll it over long enough and lower enough interest rates, that will restore Greece's debt sustainability because if you in essence lend Greece 300 billion euros for 100 years at 3 percent, that will be sustainable.

ZEDILLO: You have to watch what happens with the IMF program.

RHODES: Exactly.

ZEDILLO: There were some news last week in the sense that they were failing to meet some of the targets. So you have to watch what will be the IMF and the European stability facility reaction if they start failing to meet the program. Are they going to be flexible and adjust the economic program? What are they going to do? I think they will not shoot on their foot.

RHODES: I have two points, Roger, just picking up on what Adam and Ernesto said. First of all, I think people should not forget that the IMF is inextricably linked in here with the EU. So it's not just an EU decision by itself. And the IMF has certain parameters they have to keep. Second of all is the banking system because there are thoughts that the EU is pushing this thing along to give the banks enough time to raise additional capital and as you know, because we've got a lot of expertise sitting in this room in this area, over the last couple of months a lot of European banks have been in the market raising a lot of capital because, you know, we have the famous stress test second round.

We saw what happened in the first round. They passed all the Irish banks in the first round and you see what happened there. The second round is supposed to be more like what happened in the United States a couple of years ago with stress testing. And so the banks are pushing very hard to get themselves to that level and to Basel III plus levels. I don't think this thing will go on in the sense of some decision-making seven years, five years, four years, three years.

The situation -- there are a lot of similarities with Latin America but i think the markets are much different. They move in nanoseconds today. I saw the difference between the Latin American debt crisis and the Asian financial crisis which hit us in '97, '98 in the sense of how the markets work. And they work much more rapidly today. And then, as I said, remember Spain. If this thing gets constantly pushed out, that does put additional pressure on Spain and Spain is EU's fourth largest economy.

As I said, I think the Europeans and the IMF underestimated what they should have learned before because, remember, they were great at preaching to the Latin Americans, great at preaching to the Asians, as we were here in the United States, in the sense of the question of timing and the whole question of contagion.

So one theory that was given to me by a famous central banker who just stepped down in one of the northern countries was that -- you can probably figure out who that is -- is that at the end of the day, if what Ernesto and Adam are suggesting, that this thing could be pushed out that far, that really what you need if the EU is going to succeed over time is some sort of a Marshall Plan for Southern Europe or what West Germany did with East Germany because the differences between Southern Europe and Northern Europe are so great in so many areas that if the EU is going to be sustainable over time, there needs to be some sort of program like that.

And I mentioned this in front of my good friend Jean-Claude Trichet about three weeks ago and he was very surprised when I said it. This was in a group meeting. But I think that this thing has longer legs to it than I think a lot of people give it. It's not just a simple one or two countries getting into trouble. It's got a lot more in the way of ramifications for the EU going forward on how this thing is resolved and how it needs to be resolve in an orderly fashion for the EU, for the banking system in Europe.

ALTMAN: Let me ask this question. I'll start with you, Adam. What is the interplay of this crisis with the implementation of Basel III as follows? Arguably one of the many, many, many implications of the credit market collapse and the "Great Recession" is that we need Basel III to be serious and strict and everyone has his own or her own exact definition of exactly what that means. But my question --

LERRICK: That's the problem. (Chuckles.)

ALTMAN: Okay, but my question is does this continuing crisis make it a lot less likely that the final outlines and implementation of Basel III will be as forceful as at least some would want it to be? Is this crisis in effect inevitably going to weaken that?

LERRICK: I think inevitably it will delay the strict implementation of Basel III or any other banking regulations. Picking a point that Bill raised, you talk about the role of the IMF and flexibility and their policies -- Ernesto raised the same thing. I'll remind everyone that every quarter the IMF has to do a debt sustainability analysis under every program. And it must come to the conclusion that the debt of the recipient is sustainable before it can make the next disbursement.

It has come to that conclusion every quarter with Greece. But I'll remind -- and it's going to do it again at the end of this month. I'll remind everyone that debt sustainability analysis is based on assumptions. And the assumption in that analysis s that Greece can access market financing at 7 percent per annum -- long-term market at about 7 percent this year and 6 percent next year going forward.

And that's the assumption. So you can change all the assumptions and if you use that assumption they'll come to the conclusion Greece's debt is sustainable. The same thing will happen in Basel III and the banks. They'll make other assumptions such as there can never be a default in the sovereign area.

They'll make an assumption that we'll always be sure that there won't be a write-down of capital, that any restructuring will be MPV neutral or any restructuring will not cause a write-down of the nominal claim of the assets in order to achieve -- you know, pass the stress tests even if you write the regulations very, very strictly.

So I think what you're going to see is there's going to be, as always, a fudging factor going forward. Either they'll make the regulations a little less strict or they'll delay the implementation or they'll allow the banks to make favorable assumptions in order to achieve the results they want.

ALTMAN: Ernesto, let me ask you this. Is there a serious scenario under which any of the current members of the Eurozone choose to or are forced to withdraw or drop out?

ZEDILLO: Well, if they are tempted to think about it, which I guess in the game of scenarios, you have to do it if you are a responsible policymaker. But then you think about the consequences of that for your own economy. Then I think they will be more willing to take what it takes to remain in the union.

The consequences of withdrawing from the union at this point for the banking system, for the payment system and for the economy at large will be so huge it will be devastating and that I think they will come back and say, you know what, lets' see what it takes to do well within the union.

I think that's very important. At least that's my assessment. There are some economists who say, oh, they should go out for a while and then come back. Well, I don't think those people have been, as I have been, close to a situation in which your payment system is about to melt down.

I think that has been one big problem in this country, that the government failed to explain to people. And of course, at the moment it was impossible to do it because you would have increased the panic. But the problem is that after the emergency was overcome, nobody came out and told the truth to the American people, what we went through in September and October of 2008.

We were just one step from seeing the whole payment system to collapse. And I think the Fed and the treasury and the president of this country realized that and act in consequence. And they were right in doing what they did, as I think I was right in my country to prevent the collapse. So I think the leaders in those countries will see exactly the same, you now, what is the cost of allowing your payment system to collapse. And then they will stay in the union.

ALTMAN: Adam, do you and Bill agree that the EU will remain intact?

LERRICK: I think this is a very strange argument, that somehow if you have an unsustainable debt you have to leave the currency union in order to restructure the debt and remain sustainable. I don't think they're linked at all. I think it would be a disaster for Greece to leave the union. I think the people that propose, as Ernesto said, that you sort of take a time-out, you leave for five years, devalue your currency, come back in.

That is a terrible idea because that turns the euro into nothing more than a regular fixed exchange rate system. People go in, people come out whenever they want to adjust their price level. I think the idea that in order to restructure debt or default even on your debt, you have to leave the union is a very strange idea. We had New York City and Orange County both default in this country.

I never heard anyone say they had to give up the dollar and start their own currency. And I think that's the same thing in Europe. There's no need to leave the union to restructure debts.

ZEDILLO: Yeah, the argument is that you have a straightjacket with a fixed exchange rate with the euro and you want to grow based on exports -- outgrow the debt, then you have that straightjacket. Well, there are other ways to sort of gain competitiveness other than devaluing your exchange rate, particularly if the opportunity causes one to be so high.

RHODES: I don't think that the Greeks or anybody else are thinking of leaving the Eurozone. I do think it's fair to understand that so many of the Latin American countries and in Asia also, they were able to devalue their way out as one of the major tools which makes it all the more difficulty, which is why I say you've got to have a plan that's reasonable that leads to growth and convince your people that the austerity program will lead there because you don't have the easy way out of devaluation.

One of the things that's being contemplated as another measure -- it was turned down. The Germans opposed it. But it's still on the table -- is that they allow the bailout fund and the ECB to go in and buy on the secondary market. And of course Ernesto referred to the reserve which has in a sense led to Angel Gurria -- since his name was mentioned -- started saying, well, we want to capture some of that --

ZEDILLO: He wants the gold. (Chuckles.)

RHODES: And so I think that this is something, Roger, that may occur. It was turned down the first go around and what they approved was that the fund could go in and buy bonds and, you know, country-issued bonds but not go in a secondary market. And so one of the instruments to buy time that they're looking at again is to allow the ECB to go in. But the Germans have opposed it.

So I think that there is a timeframe here vis-a-vis what'll happen to these countries if they cannot turn this thing around in a more, let's say, rapid fashion than five, six, seven years. And I think if we had the Greeks here right now that they would tell you that their plan is to try and go back to the voluntary markets within a couple of years. But they need more time. They're not asking for more money.

They're just asking for more time and lower interest rates. And at the end of the day, and many of you in this room participated working with me on these various restructurings in Latin America and also Asia, is that what we wanted to do was to buy enough time so these countries could get back to the voluntary markets. And that's what has to be at the end of the day.

And I think the containment phase, as Ernesto mentioned it, I think has gone on, you know, now over a year and we still are getting contagion. So I think some tough decisions have to be made on the part of both the EU and the IMF with some of the points we've raised here. I mean, this can't go on forever. I think conditions are different, Ernesto, than they were in Latin America in the 1980s. And we've mentioned a number of them -- exchange rates, how the markets move, the conditions of the banks.

So I think there are similarities in the sense that every country is different. Contagion was always there, underestimated, strong leadership, the role of the private sector in these programs that are being put forth. The private sector has to play a lead role because at the end of the day the private sector in most of these cases holds a majority of the debt. So I think this is key.

And then very importantly, as I mentioned earlier, you've got to be able to show the people of these nations that at the end of the day if they accept these austerity measures that there's some growth, which is what the Brady Plan did.

And you know, maybe we'll end up with some form of that but on a voluntary basis. So A, I don't see any of these countries leaving the EU, number one. And number two, I don't see a default. What you will do is to have something voluntarily occur if they can't bring it off otherwise.

ZEDILLO: Yeah, voluntary with quotes, just as the Brady was not really --

RHODES: Exactly. (Laughter.)

ALTMAN: Okay, let's open this up -- let's then open this up to questions. We have microphones throughout the room. So please wait for the microphone.

ZEDILLO: I sold it as voluntary.

ALTMAN: And as I said before, please identify yourself before you ask your question. And Frank, I'll call on you first.

QUESTIONER: Frank Brosens, Taconic Capital. Just curious if sustainable debt to GDP ratios played a role in Latin American restructurings and if so, what the implications are for Europe.

ZEDILLO: The debt indicators of Latin America, at least before the Brady Plan, were better than what they are for Greece, Ireland and Portugal. By that time, we had ratios of debt to GDP which were considerably lower than what we are seeing in those countries. I think the fact that we needed to go into something like a Brady Plan, at least in the case of Mexico, if you remember, is that -- well, of course we hadn't been there for a number of years with practically no growth.

And on top of that, we had a huge external shock in 1986 when the price of oil dropped dramatically. That implied that we lost almost one-half of our oil export earnings. So that really put a dramatic squeeze on the Mexican economy. In addition, at the end of '87 we had launched a very severe stabilization program that require a lot of additional internal effort. I will not make the list of actions that had to be taken because they were too painful to be repeated.

And I think that also posed sort of, I would say, political necessity to say, okay, we have done all of these over these seven years. We had confronted this huge external shock starting in '86. We had to go into a dramatic stabilization program to prevent Mexico going into hyperinflation.

So we need some burden sharing, which by then had not occurred. And I think this was very important that the Mexican government -- or I would say the Mexican elect government at the time -- convey this message to the U.S. elect government in the fall of '88.

And I think that was really the origin of the Brady Plan. Later Secretary Brady was part of that team of the president-elect. And he heard the argument of the Mexican part. And in fact even before that, David Mumford at the treasury had already said that. You know, there is no way we are going to avoid some burden sharing. He had already produced some notes in that respect.

So I think the time was ripe when the two new administration came into office in early '89, late '88 Mexico, early '89. Then it was just a matter of weeks before Secretary Brady went out and said, you know, we need to do that. By then, the banks were ready.

RHODES: I think there were a couple of other factors that I'd add to what Ernesto said. One, and some of you remember it because you worked on it, was the so-called Baker Plan. And the Baker Plan went on for a couple of years and it was basically to raise new money in the sense of putting out the maturities. But by the time that Nick Brady got there and President Bush One, it was apparent that this was not going to do the job.

And then in addition to what Ernesto said about Mexico, some of you may remember that under Carlos Andres Perez you had massive riots in Venezuela and Caracas. And you had hundreds died for the implementation of an IMF austerity program. So I think all of that together convinced Nick Brady and President Bush One that they had to do something and I think that was the origin. But I think Ernesto is very correct vis-a-vis the ratios.

They were at -- by that time they were -- they were better. So and again all of these lessons -- when I talked with the Europeans I try and mention to them. You know, and some of them were very much involved. There was nobody more involved in this on the government side than Jean-Claude Trichet who was head of the French treasury at the time all this was going on and then the Banque de France and who is now running the ECB. And there were some others who were too.

So I mean, it's not that the policymakers in Europe -- at least some of them are not aware of some of these lessons and they also, in addition to Latin America, Roger, as I said, you had similar lessons in Asia with what Korea went through and Indonesia went through. Mark remembers this very well. So there's a lot of, I think, lessons learned and experience here which unfortunately I think has not been utilized and why?

For a simple reason, because a lot of Europeans say we are different because we're a developed country. It's just like we here in the United States say, you know, we have the reserve currency of the world and it's now finally the idea of our deficit is coming home to roost. And too often I've found over the years the so-called developed countries of the world have been preaching to the so-called lesser developed emerging countries.

And of course we've now seen a shift. So I think all of these lessons should be taken into account by policymakers in Europe because I think it would shorten the span of getting this particular question involved.

ALTMAN: Okay. Yes, sir, over here? Yes, sir?

QUESTIONER: Hi, I'm David Malpass. I would thank you for this very interesting discussion from everyone. I wonder if we could get specific about what the decision parameters might be this summer. So as I understand it, and correct me, Greece -- let's say Greece can't comply with the austerity program because it takes a long time to really privatize and do the things that are really needed. And the IMF can't -- as Adam was saying -- can't keep saying that their borrowing costs are 6 or 7 percent.

So I'm wondering from the panel what hard decisions need to be made. Specifically, does the ECB need to be willing to take a haircut on debt that it holds or does there need to be lower interest rates on the Greek money coming from the IMF? What concrete things could be done this summer in order to allow Greece to over the next two years go forward with this program?

ALTMAN: Adam, do you want to start with that?

LERRICK: Sure. First, I'd just like to comment on one of the questions that was raised. What is the sustainable debt ratio? It depends on two factors that weren't brought up. One is the domestic savings rate and two, what is the growth prospect of the country and three, eventually, how much of your debt is held by foreigners is the final question.

And I don't think anyone even at the IMF would have said that a sustainable debt ratio is 170 percent of GDP. And yet that's what they're saying Greece is sustainable and they'll be fine. David, I don't -- unless Greece gets way out of compliance with conditions, I don't think anything has to happen this summer.

They can have their review in June. They'll say Greece has more or less fulfilled its requirements. We've all seen this on IMF programs before. We're going to disperse the tranche. And the Greeks will say, next time -- this time we really promise to fulfill the commitments. (Laughter.)

Okay, and then they will come to September and they can do the same thing. They can say, well, they more or less are in compliance and this time they really, really promise to come into compliance. The end-point is next February when the money actually runs out. At that point, something has to be done.

Either the EU and the IMF have to increase the loan -- not extend the loan -- have to literally put in new funds or something has to happen with the private bonds. If the EU and the IMF decide to put in new funds -- let's say another 50 billion euros -- that will get the Greeks for another two years, then you have another problem.

By that point, you're going to have close to two-thirds of Greece's debt will have moved off the balance sheets of private investors onto the balance sheet of the official sector. Then you have a real problem with debt restructuring because even if you wipe out the entire debt held by the private sector, Greece's debt will not be sustainable. And that's what they're -- that's what they see coming down the highway but they haven't been able to address it yet.

ALTMAN: Yes, sir, here in the front?

QUESTIONER: I wondered, Bill, what kind of Greek things this summer are needed

RHODES: Well, the Greeks are saying that if they move ahead with their privatization program, which is key because they can't make this program work if they don't start their privatization program -- but they're saying if they -- if they start that in the next couple of months, what they are looking for and both Papandreou and the minister of finance have said this -- is they want longer maturity rates and lower interest rates so that they'll be able to bridge the gap that Adam talks about in February.

It's not clear in the case of Portugal because we don't know what that program is going to be. And in the case of Ireland, basically what the Irish are looking for is something similar. But I think everyone recognizes there are going hits vis-a-vis the Irish banks. But that's a specific answer as far as I can give it to you on what the Greeks are looking for before February. I mean, they don't want to run up into this -- into February, which is the critical date, as Adam mentions.

ALTMAN: Yes, sir?

QUESTIONER: Hi, Blake Haider from Citi. I want to expand a bit on something Ernesto said about the end holders and recognizing a bit that -- well, going back to Bill's point on raising new capital for the French and German banks -- most of the sovereign restructurings -- depending on how -- whether a default had occurred or not occurred -- involves some sort of exit instrument that allowed the banks to preserve a prior claim, i.e. not take any write-down or haircut.

How big of a problem ultimately is it with EU and principally the French and German banks in terms of getting new capital and how much capital is necessary do we think if there is some sort of restructuring?

ALTMAN: Ernesto?

ZEDILLO: Well -- (chuckles) -- you know, that depends on what kind of haircut eventually will be needed. And I wonder to make, you know, a superficial or silly calculation about that. What I do know is that having ratios of debt to GDP of 120, 130 percent -- those are too high, that still 90 percent looks high.

So anything below 90 percent probably will make it sustainable. And from there you can start making some mathematic of what would be the implications for banks and also for bondholders. So it's substantial. But then the question is at what moment this exercise of burden sharing can really politically and economically start.

When are you ready to do something about the banks politically because right now I think the problem is being, you know, managed without making evident that ultimately you will have to support the banks.

RHODES: I think a lot of people think, as a matter of fact, that this whole exercise -- this containment exercise, to use Ernesto's word -- is basically buying time for the banks to increase their capital and reserves so they're in a position to take the hit.

ZEDILLO: Or politicians to take the hit for putting tax -- expensive tax money into the banks.

RHODES: Exactly.

LERRICK: And I think one thing -- there's no -- the only banks that are really at risk are the Greek banks. If you look at any of the major European banks -- it was calculated last week that if there's a 40 percent haircut on Greek debt, the ENP -- which is the largest holder of Greek debt in France, it would reduce their earnings by 10 percent -- not their capital, just their earnings this year.

And the German -- even the German public bankers association has said their can survive a write-down. Whether there's some institution to there that can't, that's very possible. But it's really the Greek banks that would be bankrupt if there's a write-down.

ALTMAN: Yes, sir?

QUESTIONER: Hello, thank you. It's Tim DeSieno from Bingham McCutchen. And Adam, your comment may go a way to my question. I'm trying to live somewhere between the containment of the last year and the need to afford time to the banks to raise capital. And I'm wondering if the panel would comment on a little event in Ireland in the last few weeks that I think is very concerning in that respect.

And I'm referring to the subordinated liabilities order in respect of allied Irish banks by Minister Noonan and what we consider to be effectively the subordination of debt to equity by statute and then by ministerial action. And you'll forgive me, as a creditor's advocate, my phraseology would be if he gets away with that, what impact will that have on the other banks within Europe raising capital in time?

Will the European policymakers look at this and cause a pushback and a change in direction from hat or will they cheer it as a pathway to burden sharing or will they yawn or how will this play out?

ALTMAN: Okay, just before we answer that, we want to get a few more questions in here. So let's try to give ourselves time for three or four more. And so in that spirit, Bill, would you answer that?

RHODES: Well, I think that that's why I mentioned earlier that a lot of people perceive that what you're saying is going to happen and a lot of policymakers are looking the other way in Europe because it's not the sovereign in the sense. It's the banking system. So they feel this is the burden sharing coming home to roost and that's particularly true with policymakers in Northern Europe. So I think that's something to be concerned about.

ALTMAN: Yes, sir, in the middle?

QUESTIONER: Thank you. I'm Jon Weber from Anchorage Capital Group. And Ernesto Zedillo, you mentioned that there was lower tolerance for pain and I assume you were serious in making that comment. I was hoping you might -- and perhaps Bill Rhodes you might expand upon that as it relates to the limitations on levers for structural adjustment and the limited -- perhaps lesser ability of these debtor nations to cause their populations to become, you know, competitive and absorb the debt load.

ZEDILLO: Well, probably you have heard this expression -- the lost decade of Latin America. And that basically meant that per capita income not only was stagnant but actually decreased during that decade for most Latin American countries, that real wages in real terms fell significantly. And I could make a very long list of I would say social and human costs and economic costs that was paid because of the debt crisis, which by the way, it was caused to a great extent by policy mistakes.

Of course, a debt crisis is always a crisis of over-borrowing and also a crisis of over-lending, right? They go together. But we over-borrow and then we have to pay a huge price for economic mismanagement. It will be very hard for me to say to see that the kind of social and economic costs that we took in Latin America would be taken by any, you know, peripheral European country. I think before that happens, other things will happen and not necessarily bad.

I think the European solidarity will come into play. After all, they have an institutional strength that probably we didn't have in Latin America. So they will be faster to adopt the right policies once certain rigidities are overcome. So I don't see the process as, you know, as painful as it was. And it will not be tolerate and I think it doesn't need to be that bad.

RHODES: Well, I would just add to that that I don't think the populations of these countries -- the peripherals -- will put up with what Latin America did in the 1980s and early '90s, number one. And I think that that's why I don't feel that this thing is going to go on five to seven years. It's got to be settled beforehand.

You know, if the EU is going to hold together which is why my friendly central banker suggests at the end of the day you might have to have some plan to bring up these countries to the other level. It sounds outlandish but, you know, if you had talked about a Brady Plan possibility five, six years earlier, you wouldn't have gotten the policymaker in this country or any other country to agree that this could happen. So I think we still have a lot to be seen coming out of this crisis.

ALTMAN: Yes, sir? Yes, sir?

QUESTIONER: I'm Matthew Lee, Inner City Press. I wanted to ask Mr. Lerrick, you had said -- talked about the impact of possible restructuring on banks like BNP Paribas. But is this call for, like, bank consolidation and mergers, is that something that you see, like, is it better for it to be done by, you know, big banks buying the peripheral banks or consolidation within?

And I wanted to ask the two Citigroup panelists -- connected panelists -- these charges by Greece against Paul Moss, the trader, for they say -- they say pushing out rumors about restructuring, what do you make of them and how do you distinguish, you know, with all due respect, some of the discussion today with --

ZEDILLO: The gentleman is retired from Citi and I am a board member and I never comment on Citi's -- (laughter).

RHODES: And a former client. (Laughter.)

LERRICK: First, your question about consolidation of banks, it's very clear. Weak banks have to disappear. Do they do it through consolidation with strong banks? Do they do it by liquidation? To me it's basically a matter of indifference. But they have to go. You can't just keep pouring taxpayer money in to keep them alive. I would like to just mention one point to the previous question about how much pain the Greek or the Portuguese or the Irish people will take.

Remember, you've taken away from these governments the best tool to inflict the pain, which is devalue the currency. So the only way they can do it now is by deflation and forcing wages down. That's the only way they can gain competitiveness and that's a much more painful, drawn out and resistive process. And that's what you have to realize, why there will be much more difficulty implementing necessary adjustments.

ALTMAN: Yes, sir?

QUESTIONER: Brian O'Neill with Lazard Freres. I'd like to go back to a comment that President Zedillo made about we don't know who's at the end of the line. And it seems to me that one of the bigger difference now versus Latin America was in Latin America the official creditors were IMF, World Bank, IDP and Paris Club. This time, the big official credit that's different is the ECB. The ECB started financing the national banking systems of a number of these countries initially when they were chased out of the inter-bank markets as a liquidity matter. But it seems to me now they have been financing what in essence has been the national banks buying the sovereign bonds.

And many of these national banks are now chockablock full of sovereign bonds. And of course official creditors haven't in the past been willing to take haircuts. And so I just wonder how the ECB gets out of that sticky position and it also makes it a bit of a judge and jury issue because it is one of the bigger creditors.

ALTMAN: Bill, do you want to start with that?

RHODES: Well, I think that Brian has put his finger on a very difficult point because I think over and over again the ECB whenever one of their directors of their executive committee talks, it says that this will not occur, that the ECB is not going to be -- first of all they say they're not going to continue to finance forever the banking system, that this is very temporary to allow them to raise capital and reserves, et cetera, and second of all, they don't contemplate any sort of haircut for the ECB.

ZEDILLO: Oh, by definition the ECB cannot do the haircut. I mean, it's a central bank and eventually its capital will have to be replenished. So that's not really the issue. I think the question is who will play the role that was played by the IMF, the World Bank and the Japanese Export-Import Bank in the Brady Plan. I think that's the bottom line of your question.

And I think the answer is very simple. The ESM -- the European facility mechanism -- the new name -- is the ESFS, whatever, and the ESM. Ultimately, they will have to play the role when the day comes the enhancements will have to come from that facility, not the ECB. By the way, the ECB, you know, has taken a lot of these assets at a discount. So it may not even be the case that they need to replenish the capital of the ECB. The discount that they have been --

LERRICK: About 80 -- they've bought about -- 80 is about their average cost.

ZEDILLO: Yeah, well, so it's about --

LERRICK: But Brian, if you want to create a transfer union, that's the fastest way to do it because if the ECB has losses, the shareholders bear the loss in proportion. So that's a quick way of having a transfer from the north to the south.

RHODES: Well, that's one of the things that I mentioned earlier that was on the table and rejected by the Germans and others, which was that this facility be able to go into the market and buy the paper at a discount. Now, it was turned down the first time but that doesn't mean it won't happen. But the ECB itself will not be taking an official hit.

LERRICK: Key word, official.

RHODES: Exactly.

ZEDILLO: No, the ECB cannot take it.

LERRICK: It's like key word, voluntary.

RHODES: That's why I said official.

ZEDILLO: Capital would have to be replenished.

ALTMAN: Okay, I'd like to close this if I could by invoking what I'll loosely describe as the host's prerogative by asking one final question myself, which is this. The outlook for European growth is poor. And as somebody who works with a lot of multinational corporations, I hear the following all the time. The United States outlook is tepid. Europe is very bad. And Japan is zero. Therefore we're going to reposition our business even though it's going to take many years toward the bigger burgeoning markets.

In other words, people are beginning to look past as it relates to investment and reliance for a platform. And this problem we're discussing this morning is playing a major role in that, at least from the point of view of confidence.

So my question is can Europe return to what most of us would call healthy growth rates from a historical point of view, let's say over the next five years, or is the prevailing view at least in the multinational corporate community, that he answer to that question is no, a correct one? Adam, what do you think?

LERRICK: Oh, I think Europe could return. Well, what is healthy for Europe -- 2, 2-and-ahalf percent? Roger, would you consider that healthy growth for Europe? Europe can easily return to those growth rates. What they need to do is quickly clean up as fast as possible the excessive debt of their over-indebted members and the excessive debt and lack of capital of their banking system -- of the banking systems that are at risk.

If they do that quickly, they will return to growth quickly. If they drag this on for five years, it'll -- there will be a lost decade in a large portion of Europe. Now, that is to the advantage of Germany, of course, because that will keep the euro down.

Remember, Germany benefits from the euro being kept down by the weakness of the peripheral members because Germany relies on exports for growth and that's what we've been seeing for the last four years. And when we talked a little bit about would the euro disintegrate, would people leave the euro, that would -- the country that would pay the highest price of that --

ALTMAN: Germany.

LERRICK: Would be Germany.


LERRICK: Because all of a sudden the hard-fought gains of seven, 10 years of productivity gains, low unit labor costs that have increased their productivity and lowered their cost by 29 percent compared to the rest of the EU would be wiped out overnight. There would just be an appreciation of the new deutschemark and Germany would be back where it was seven years ago.

ALTMAN: Ernesto, what's your view?

ZEDILLO: Well, I think -- as Adam said -- Europe can go to normal European rates of growth. Germany is there, by the way, the largest economy. I don't think structural reforms that are needed are impossible to carry out in Greece, Portugal. In fact, Ireland, by the way, has been amazing in terms of what they have done after the crisis.

I mean, in Ireland you had nominal reductions in wages. The problem that they have is a terrible debt overhang. And I'm sorry to tell the gentleman here that -- (inaudible) -- because there is no other way that this will be solved but to have a haircut eventually. It will be a very organized, well-managed, civilized, you know -- (laughter) --

LERRICK: Voluntary.

ZEDILLO: Voluntary, a la Rhodes -

LERRICK: Market friendly and voluntary.

ZEDILLO: But it will happen. And it will be before seven years, Bill. Don't worry, well before. But it will not be this year, okay? So yes, Europe can have those kind of rates. But of course, as Adam, said, you know, population growth is nil in Europe. So don't expect Europe to grow as the U.S. -- as the U.S. should grow eventually or Latin America or Asia.

ALTMAN: Bill, you get the last word.

RHODES: Yeah, I would just say, as my colleagues have said, Germany is in the best position it's been in years. Their unemployment rate is down to 7.1 percent. They haven't seen that in decades. Of course, they're living off of the export, particularly to Asia. But the differences are growing, as I said, between Southern and Northern Europe. But even in Eastern Europe, take a look at a country like Poland who implemented a proper policy.

So if -- I think you get the proper policy mix, they'll get it. In the case of Ireland, their fiscal situation wasn't bad until they decided to guarantee the banks. They had actually done a very good job. And we're all waiting on the outcome of what happens in the U.K. That's Europe, although it's not the EU -- in the sense of -- in terms of program. So I think that Europe can get its act together but they've got the face this particular crisis that we're talking about here.

And the final comment I would just make, Roger, is that as you travel around to China, Brazil -- I just got back from Brazil, the World Economic Forum -- you know, the flows are going that way. The flows are going east. They're going south. But these countries have their own problems with inflation, et cetera. And I frankly think that the world's facing some of its more difficult problems than we've seen in a long time, particularly when you come out of a "Great Recession".

Everyone's very optimistic, 4 or 5 percent growth in the developed world. We're not seeing it. And it's -- you know, what's happening in Europe that we're talking about is holding this down. And as you write so well about the U.S. deficit and the problems we have in the United States and you talk about a lost decade -- you know, Japan is now going into lost decade and a half.

So I think the developed world has really got to get its act together going forward. And the test of Europe is, I think, very much how they're going to handle this problem and the test of the EU. And if they can get through this and handle it well, then I think the future is bright. if not, I think you will continue -- you continue to see struggles in the EU going forward because having Germany so far out for the rest of these countries is not a healthy situation. I'll just end with that.

ALTMAN: Well, let's thank the panelists for a very substantive -- (applause).







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