LONDON Feb 16 When a bankrupt Mexico
stopped repaying foreign loans in 1861 after three years of
civil war, Great Britain, France and Spain responded by invading
the Mexican harbour of Veracruz.
Britain and Spain pulled back almost immediately on promise
of future payment. France invaded, installed an Austrian as
emperor, and was not driven out for another six years.
Since the second Hague Convention of 1907 banned the use of
violence to collect debt from other countries, recouping
sovereign debt has called for a very different kind of
diplomacy: the generals now orchestrating repayments are a rare
breed of specialist lawyers, academics and fund managers.
And as an intellectual battlefield, Greece is as good as it
The southern European country needs to cut its debts by 100
billion euros ($130 billion) - the biggest national debt
restructuring ever and far larger than Argentina's $87 billion
default of 2001, which is still being fought out in courts.
A deal to restructure Greek debt hangs in the balance after
more than half a year of arduous negotiations, default looks
inevitable, and Greece's chances of staying in the euro zone
single currency are at risk.
If it happens, it would also be the first time a country has
defaulted within a currency union, which means that the informal
framework normally used for restructuring a country's debt is
even less of a useful guide than it normally is.
And it's not normally very useful: there are no hard and
fast rules on what to do when countries run out of money to pay
their debts, and the handful of people with expertise in the
field are asked for new ideas each time it happens.
"The more I get involved ... the more I am astonished by the
piecemeal approach that has been taken throughout the years,"
said Emilios Avgouleas, a professor at the University of
Edinburgh, who also advises a group of bondholders.
"(It's a) chaotic structure (for a) process that is one of
life and death for whole nations," he said.
Though full sovereign debt defaults are not uncommon,
defaults by major economies are relatively rare, so there is no
set procedure for handling them.
"In each of these restructurings, you can develop a new
tool. You keep adding new tools to your tool kit and the next
time you go back and see what best fits," said Rodrigo
Olivares-Caminal, a lecturer at the University of London. "There
is no formal framework, there is an ad hoc legal framework that
is mainly construed on previous experiences."
NO SUCH THING AS SOVEREIGN DEFAULT
Consequently, a small number of towering figures who have
earned their stripes in previous sovereign debt restructurings
dominate the area. One is Lee Buchheit, the Cleary Gottlieb
lawyer whose firm advises the Greek government.
"Buchheit has taught all of us. He is the God of sovereign
debt restructuring," Avgouleas said.
At the other end of the negotiating table, he faces Philip
Wood, a veteran from London magic circle law firm Allen and
Overy, whose firm represents bondholders.
Wood was part of the team involved in Argentina's debt
restructuring and advised a number of banks in the 1980s at the
height of the Latin-American debt crisis.
The Greek government also gets help from investment bank
Lazard - notably from Mark Walker who used to work at
Buchheit's firm Cleary and Gottlieb. Blackstone and law
firm White and Case also work for the creditors.
The most fundamental problem these advisors face is that,
strictly speaking, there is no such thing as a government
default. Banks can take hold of a company and sell whatever of
value is left, but not with sovereign nations.
"Neither the government of a sovereign can be replaced nor
can the sovereign be closed down and sold to the highest
bidder," said Olivares-Caminal in a paper that he provided at a
conference at the Bank of England last week.
Vulture funds - hedge funds that buy distressed government
debt then aggressively sue governments in courts all over the
world in the hope of securing a bigger pay-out - can be more
After years of legal battles, Elliott Associates, one of the
best-known hedge funds pursuing these strategies, in 2000 won
$56 million from Peru - which had defaulted in the early 1980s -
for loans Elliott had bought for just $20.7 million.
CLUBS FOR DEBTORS
In 1902, Venezuela agreed to a debt restructuring only after
a naval blockade by European countries and the United States.
Nowadays, countries normally receive an international
bail-out under the auspices of the International Monetary Fund
when they default. They then let their currency devalue, which
sparks exports, and economic growth.
Governments in 1956 set up the so-called Paris Club, where
they work out deals for countries that can no longer meet their
debt obligations. Since its inception, it has reached more than
400 deals with 88 different countries.
Argentina alone has worked out 8 different debt
restructuring deals with the Paris Club, according to its
website. Russia has struck 5 such deals. There are few European
countries on its list, and no European Union members.
A similar group for private creditors is called the London
Club, a far more informal gathering that finds its origin in the
era when the City of London provided most debt financing to
governments through syndicated loans.
In the Greek debt workout, a group of banks lead by the
Institute for International Finance (IIF) lobby group similarly
tried to reach a voluntary deal, though the jury is still out as
to how successful that will be.
Part of the confusion is because of a lack of standard
contracts when governments sell bonds, and market
participants as well as experts have proposed tighter rules for
"These contracts are poorly adapted and, to be frank, poor
quality. This documentation creates uncertainty and leaves space
for interpretation," said the two authors of another paper
presented at the BoE's seminar last week.
The International Capital Markets Association (ICMA) lobby
group has suggested changes from simply making bond contracts
readily available and translating them into English, to clearly
state what happens in case of a default.
There have also been proposals to change the way sovereign
debt is accounted for in banks' books and to the way the Credit
Default Swaps (CDS) - financial instruments that can be used as
an insurance against defaults - operate.
At such times, the views and research of academics is drawn
on heavily: professionally, if not personally, satisfying for
those who have devoted their careers to study in this field.
"I prefer to have peace and quiet and more normal times for
the people of Europe," said Elias Karakitsos, an academic who
was long-time economics professor at Imperial College in London.
"It's very, very bad psychologically."