February 16, 2012 / 2:35 PM / 6 years ago

Default experts: the Greek sovereign debt gods

LONDON, Feb 16 (Reuters) - 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 gets.

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.”


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 successful.

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.


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 the future.

“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.”

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