Roubini and the Nonsens of Voluntary Bail-ins

There’s plenty of nonsense circulating on the subject of dealing with the European debt crisis. Professor Nouriel Roubini takes a shot at one of the latest genius ideas – an “induced voluntary bail-in” of the Greek bank’s creditors…  Now, don’t ask me how that is supposed to work….

“Trying to apply something that was originally designed to bail-in cross-border short-term interbank lines among banks to the bonded debt of a sovereign is a big fudge.”

Nouriel Roubini

“Now that the ECB has, for the time being, effectively vetoed any bail-in of Greece’s creditors, even a modest profiling of the debt, the official sector is running out of options for a meaningful bail-in of creditors.”

The following article is written by Professor Nouriel Roubini and syndicated by eurointelligence.com:

The latest idea — apparently deemed acceptable even by the ECB — is a “voluntary” maintenance of the exposure of Greece’s bank creditors by inducing them to hold their exposure to the sovereign once their bond claims mature by rolling over their maturing bonds into new bonds.

This option has been compared to the Vienna Initiative, which induced the cross-border exposure of foreign banks to the central and east European banking system during the 2008-09 global crisis, when a number of sovereigns and banking systems in that region were at risk of rolling off the claims of foreign creditors.

However, the idea of bailing-in cross-border exposure to the banking system of a country under financial pressure has a longer history and includes similar bail-ins of foreign banks’ cross-border exposures to local banks in 1998 in South Korea, in 1999-2000 in Brazil and in 2001-02 in Turkey.

The more successful experiences were the more coercive ones or when it was in the banks’ interest to maintain their exposures to their foreign affiliates.

A purely voluntary maintenance of exposure at current market rates would make the sovereign’s debt even more unsustainable and, in time, will ensure a default on the new bonds.

The only way to prevent the coupon/yield on the new bonds from being close to market rates and thus unsustainable would be to provide the new bonds with seniority or some collateral; but both options are undesirable as a rollover is not a case of “debtor-in-possession” financing and thus doesn’t justify such credit sweeteners.

If, instead the rollover occurs at original coupon or well below market rates, so as to provide Greece with some debt relief, the rollover option is not purely voluntary and has coercive elements; thus, it is not different in any substantial way from the orderly debt restructuring, or reprofiling, that the ECB and other official sector folks so vehemently oppose.

Also, banks alone would be bailed in — inducing massive inequality among creditors — and only maturing bonds would be sequentially rolled over as they mature, rather than a significant part of the debt being subject to a uniform debt exchange at a single point in time.

Only the latter provides meaningful debt relief for the debtor. Thus, there would be little debt relief and consequently the unsustainability of the debt burden of the sovereign would remain unresolved.

There is also significant risk of arbitrage as banks pass their exposure to Greek debt to hedge funds and other mark-to-market investors who will not be bailed in. Thus, the entire scheme risks to unravel if such arbitrage were to occur.

A debt exchange avoids this problem by roping in all creditors, not just a sub-set.

Only an orderly and market-oriented, but partially coercive, debt exchange could restore debt sustainability while avoiding contagion; a purely voluntary approach would make the debt even more unsustainable — and would risk eventually triggering a disorderly workout — if the rollover occurs at market rates that price in massive default probabilities.

An application of the Vienna Initiative to the issue of Greek public debt is also totally unrealistic.

If the rollover occurs at unchanged coupon (original yield at issuance), there is little difference between such a rollover and a more traditional and efficient debt exchange with a par bond and maintenance of the original coupon. Thus, trying to apply something that was originally designed to bail-in cross-border short-term interbank lines among banks to the bonded debt of a sovereign is a big fudge.

If it is done properly, it is no different from the sort of clean debt exchange that the ECB and others abhor; and if it is done on a “voluntary” basis, it creates an even bigger and more unsustainable debt monster for the sovereign.

As in the case of Argentina, which attempted a voluntary mega debt exchange at unsustainable market yields—it would ensure that a disorderly default will occur in 2012 or 2013. Thus, claiming that one can apply a voluntary Vienna Initiative to the case of Greece is just a continuation of the big fudge and delusional kicking of the can down the road that the ECB and the official sector has indulged in for over a year now in Greece.

The discussion of a Vienna Initiative for Greece shows the confusion of the official sector and of some market analysts when they talk of the likelihood of massive contagion and financial Armageddon in the event of an orderly restructuring.

Yet, they also claim to support for “voluntary” approaches.

The latter are highly contrived and counterproductive if not outright destructive of the debt sustainability that everyone is trying to restore in distressed sovereigns.

By Nouriel Roubini

Nouriel Roubini is chairman of Roubini Global Economics, and professor of economics at the Stern School of Business NYU.

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