How the Greek debt reorganisation of 2012 changed ... - Allen & Overy

18 How the Greek debt reorganisation of 2012 changed the rules of sovereign insolvency – September 2012
The other objection is that the people actually
being deprived, the people actually having to
pay, are ultimately not just the bondholders. If
we strip aside all the veils of incorporation, all
the fictions of legal imagination, the real
creditors of sovereign debtors are not the
nominal banks and insurance companies. They
are the depositors who put their money in the
banks and the individuals who have insurance
policies and pensions payable by the insurance
companies. It is therefore the citizen who has
to pay ultimately. This objection is intensified
by the fact that the average citizen does not
know this is happening and cosily thinks, a
thought mostly not discouraged by politicians,
that somebody else is paying. It hardly seems
right to run our societies on the basis of this
kind of opaque cloaking of reality.
In the end, the bondholders went straight to
the end-game, without intermittent steps. On
the other hand, although the terms of the
eurozone credits were concessionary, the
eurozone lenders did not go to the end-game
because they wanted to preserve bargaining
power over Greece so as to be able to enforce
austerity policies – the famous short-leash
approach. The result is that the eurozone
official creditors are likely to be the next in line
for haircuts or an extension of maturities if the
Greek debt continues to be unsustainable.
In mid-2012, the new bonds were trading at
less than 25c per euro. They had lost more than
three-quarters of their exchange value. In most
recent sovereign bankruptcies, the new bonds
have held their market value and so the collapse
of the price of the new Greek bonds was
remarkable. It was probably driven by the fact
that the outlook for Greece seemed so bleak
that the credit ratings of Greece remained very
low and this excluded pension funds and
certain other institutional investors from
holding on to the new bonds. The perceived
subordination of the new bonds was also not
particularly encouraging.
© Allen & Overy LLP 2012
11. Contagion risk
The Greek bankruptcy involved a major risk of
contagion prejudicing other developed
countries in the eurozone.
All major insolvencies generate the risk that the
insolvency will spread, not because other
debtors are bankrupt, but because creditors
suspect that similar debtors are likely to be in a
similar situation to the bankrupt. This
contagion risk may also be grounded in the
reality of the domino or cascade or ripple
insolvency, whereby the default of
counterparties who do not pay results in the
creditors concerned being, in turn, unable to
pay. Contagion is therefore often a mix of the
imagined and the real, illusion and actuality.
This menace of spreading sickness was
distinctly observable in the crisis of the lesserdeveloped
countries in the 1980s and also,
again, in the case of the Asian financial crisis in
1998 where the near bankruptcy of Thailand
spread quickly to other countries, such as
Malaysia and South Korea. But the risk of
contagion became a fundamentally important
risk in the case of Greece, partly because of the
fact that developed countries were involved, so
that the amounts were extremely large, and
because there seemed to be a threat to the
second largest currency in the world.
At the time, there were frequent and
increasingly unconvincing assertions that
Greece was a special case and that Greece was
“ring-fenced”.
The main form of ring-fencing was to increase
the bailout funds to the EFSF but at the time
the amounts were not sufficiently convincing to
disarm fears about the spread of the risk to
other countries in the eurozone.
The risk of contagion was compounded by the
fact that the banking sector was in a bad state.
Banks had been badly hit by the bursting of the
property bubble. It was not easy for them to
raise additional capital to replenish their
existing capital or to satisfy the massively
increased capital requirements imposed by
regulators. The inter-bank market was virtually