Analysis: Greece, Brady-style haircuts and "Barroso bonds"

By Mike Dolan

LONDON (BestGrowthStock) – Latin America’s lost decade of default and stagnation ended in 1989 only after a U.S.-backed restructuring of regional debts and some say this model should be considered for debt-hobbled euro sovereigns such as Greece.

Despite hundreds of billions of euros of European Union and International Monetary Fund firepower marshaled in its support over the past two months, Greece still cannot dispel creditor concerns that, racked by austerity and starved of growth, it will eventually have to restructure its huge national debts.

Debt market pricing has deteriorated again in recent weeks and indicates more than a 50 percent chance of a default over five years. Polls and surveys of bankers show they see at least a one in three chance of a debt restructuring over that period.

If Greece is forced kicking and screaming to default, the precedent will inevitably raise fears that other highly indebted euro sovereigns — such as Ireland or Portugal — will face a similar fate. And that fear in itself risks becoming a self-fulfilling prophecy as confidence drains.

May’s 110 billion euro ($134 billion) IMF/EU Greek bailout fully funds Greece for 24 months but what happens to the country after that? Will Greece be able to renew its access to markets at remotely serviceable interest rates?

Many think the specific Greek bailout and the wider euro zone stabilization plans should simply be used to buy time and bring bank creditors to the table.

Although EU policymakers dismiss any talk of restructuring, private sector economists are already discussing scenarios. It’s most likely Brussels and EU capitals are listening attentively.


So how does the Latin American experience inform 21st century Europe and is it worth considering a reprise of the “Brady Bonds”?

After borrowing binge in the 1970s, Mexico and other Latin countries were brutally sobered by the global recession of 1981/82 and could not service their debts. A Mexican debt moratorium in 1982 set in chain events that stifled the whole continent for another seven years.

But in 1989, the Brady Initiative — named after the first U.S. President George Bush’s Treasury Secretary, Nicholas Brady — broke a protracted cycle of country default, bank stress, creditor boycotts and IMF bailouts.

Its central idea was a comprehensive debt restructuring to make Latin American countries creditworthy again over the long term and involved banks typically writing off 30-35 percent of original debts in return for a variety of new bonds tailored to national circumstances and in some cases backed by U.S. Treasury bonds. The United States then was effectively guarantor.

By May 1994, 18 countries had Brady deals forgiving $60 billion of debt and representing about $190 billion in long-term bank claims. Its success 20 years later is marked by the fact few Brady bonds still exist. As economies improved, governments bought back their Bradys and replaced them with orthodox bonds.

Before May’s series of euro zone bailouts, Jacob Kirkegaard, economist at Washington’s Peterson Institute, called for the EU to consider a Brady-style plan for Greece involving the issue of “Barroso Bonds”, after EU Commission chief Jose Manuel Barroso.

Designers of “Barroso Bonds”, he said, could call for haircuts for creditors but also provide incentives for them to participate in an orderly restructuring or “stay in and gain.”


“The biggest lesson learned from the Latin American debt crisis was that if a comprehensive debt restructuring is needed, it’s much better to do a big one right from the start,” said Brown Brothers Harriman economist Win Thin.

Famously bearish U.S. economist Nouriel Roubini agrees and wrote of Greece this week: “It would be better to use a small amount of public money to tempt creditors into a pre-emptive deal now than waste 110 billion euros of it trying to prevent an unavoidable restructuring later.”

Avinash Persaud, chairman of Intelligence Capital, said last month’s 750 billion euro zone stabilization plan should have involved a Greek debt swap that would effectively give creditors a 30 percent “haircut” but cut market uncertainty considerably.

“The solution is akin to Brady bonds,” Persaud said, adding debt swaps could leave principal unchanged but extend maturities and cut coupons — which would even then make the debt more valuable to banks than if they realized market prices today.

“Commitments to protect the creditors in full in the short run will merely undermine them in the long run. A mechanism which meant the choice for bond holders was not 100 percent or zero would calm markets and introduce some market discipline for all euro zone members.”

JPMorgan Asset Management said there is a question over who would act as guarantor, as the United States did in the Brady Plan, though others reckon the euro zone stabilization programme could fill that role.

“The most likely outcome appears to be a debt write-off, coordinated by a central agency (ECB) but no issuance of collateral,” wrote JPAM’s Brady market veteran Keith Swabey.

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(Editing by Ruth Pitchford)

Analysis: Greece, Brady-style haircuts and “Barroso bonds”