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The R word

Restructuring is a taboo word in Brussels. This column argues that debt restructuring may be a viable option for some of the countries on Europe’s highly indebted periphery.

Rumours circulate widely these days. European policymakers talk about a restructuring of public debts in some countries (see for example Portes 2011). Rumours may be unfounded but they are telling of what people think about. Like sex in Victorian times, everyone wonders about debt restructuring but the R word remains difficult to pronounce in official circles. No one wishes to plunge into debauchery but many of us have long thought that debt restructuring was a viable option that deserves serious consideration and preparation. For that reason alone, it is worthwhile taking the rumours seriously, even if they are unfair and unjustified.

The first rumour is that President Jean-Claude Trichet has said that he does not even want to hear about the R word. The reason, according to the rumour, is that a debt restructuring would hurt some European banks.

This is a strange argument. One would rather expect the President of the ECB to be concerned with the well-being of Greek citizens. They are now entering the second year of their IMF-EU programme, the third year of recession, which is the main reason why the budget is still in deficit in spite of all the government’s efforts and good advice from all quarters.

It has been agreed that more needs to be done, which may delay the eventual recovery further. A partial debt restructuring would alleviate the burden without relieving the pressure for more fiscal adjustment; it could well make further adjustments more politically acceptable.

As for banks, either they sold the Greek bonds that they initially held, pocketing losses but avoiding uncertainty, or they are reaping handsome returns that reflect the risk that they are willingly taking. Could they be taking excessive risks? They could, but is not one lesson from the financial crisis that there should be zero-tolerance for excessive risk taking by banks deemed systemic, presumably those that keep worrying the ECB? An additional lesson from the crisis is that supervisors ought to exercise their duty with great rigor. How, then, can it be that some banks are severely exposed to public debts? Why is sovereign debt not restructuring part of the stress tests that are meant to be “serious” this time around?

A second rumour is actually spread publicly by the ECB. It holds that a Greek debt restructuring would collapse the whole Greek system, with contagion to other countries and their banking system.

This is indeed a possibility, but how bad is it really? Suppose that the haircut on the Greek debt is 50% (this is an illustrative example, not a prediction, let alone a rumour). How expensive would it be for the Greek government to recapitalise – and nationalise – its banks? Suppose that the operation would cost 10% or 20% of GDP. The Greek government is still better off, not even counting that it may make a profit when privatising banks later on, as the Swedish government did in the 1990s.

Of course, the Greek government would have to raise funds to carry out the operation, both the banks’ nationalisation and bridge loans during the debt restructuring negotiations. This is why the IMF exists. Lending in last resort is also the job of the ECB, on behalf of the Greek authorities. A strong case can be made for the ECB doing that instead of buying toxic public debts and providing liquidity to banks outside the Bagehot procedure.

A third rumour is that European officials are trying to secretly devise a Greek debt restructuring that would not involve any outright write-down, only a lengthening of maturity. As is well known, a lengthening of maturity is one way of restructuring, depending on whether the interest charge is raised or not. This may well be an exercise in semantics to avoid using the R word, which is fine as long as the procedure makes the debt burden bearable (and therefore imposes losses on the creditors).

Presumably, there would be a template that could apply to other countries as well. The devil lies in the details, however. Would the EU be involved in the operation or would it be left to each country? How would that fit with the Collective Action Clause being mooted as part of the forthcoming European Stability Mechanism? How one goes about determining the size of the concession? What happens if some banks end up in serious trouble? What happens to the debt instruments acquired by the ECB?

A fourth rumour is that the source of the debate on the R word is the German government, which now fears citizen anger on having to dole out more money to other periphery governments.

Following the Finnish elections, we see that hard questions are being asked in many countries. If, as many suspect, the main motivation behind the European Financial Stability Facility and its putative successor, is that domestic banks in some large countries are heavily exposed to periphery sovereign debts, these are good questions. Is it better to commit public money to indirectly support domestic banks? It could be more efficient, indeed, but only if the operation is successful. If it will take much more money to keep the periphery governments afloat while in a prolonged recession, then defaults-cum-domestic bank nationalisation could be the least costly option.

These are all questions that need to be addressed, whether the rumours are true or not, and not just behind closed doors.


Portes, Richard (2011), “Restructure Ireland’s debt”, VoxEU.org, 26 April.

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