The Manila Model Plan Would Place Burden for Euro Rescue on Creditors

The Acropolis in Athens: "We need to accept the fact that Greece and Ireland are bankrupt."

The Acropolis in Athens: "We need to accept the fact that Greece and Ireland are bankrupt."

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Part 2: Why Banks May not Comply with Offers

The swapping of older government bonds for new ones with a lower face value is nonetheless a daring proposal. A restructuring of debt would move the EU into previously uncharted territory. Of course, debt restructurings have taken place at different places all around the world. But Greece would be the first country within a currency union to have to restructure its debts.

One potential model from recent decades was the issuance of so-called Brady Bonds in the United States in 1989, which ended a lengthy bank crisis that originated in the 1970s. At the time, American banks had lent considerable money to Latin American countries that Mexico, Brazil or Venezuela were later unable to repay.

Nicolas Brady, who was Treasury Secretary at the time, helped both indebted nations and banks by using the same trick that the Europeans now want to try out. The banks could exchange their liabilities for lower-interest securities, or Brady Bonds, which were underwritten by the US government.

As clever as the idea of a voluntary debt restructuring of Greece and possibly other euro states like Ireland and Portugal may appear, though, it remains questionable whether enough creditors could be lined up who would be willing to go along with it.

Voluntary Debt Forgiveness Could Hit Already Weak Banks

Government bonds from Greece, Portugal and Ireland are already part of the investment portfolios of hundreds of European banks, insurers and pension funds. German credit institutions alone have €29 billion in Portuguese bonds, €27 billion in Greek government securities and €109 billion in Irish government bonds. And those risks are most concentrated in precisely those banks which are already being supported by the government.

At the beginning of the crisis in Greece, German bank HRE, which has since been propped up with €100 billion in German government money, had bonds from Athens totaling €7.9 billion on its books. Meanwhile, partially nationalized Commerzbank had €3 billion in Greek bonds. If banks were to forgive that debt, they themselves may need to turn to taxpayers for yet another bailout. That is why economists are saying that the most urgent task is to render the financial sector more resilient to crises. "The banks must get enough capital to be able to withstand writedowns due on state bonds," says Kai Konrad, director of the Max Planck Institute in Munich and chairman of the academic advisory board to German Finance Minister Wolfgang Schäuble (CDU).

Many investors may lack the incentive to engage in bond exchanges voluntarily. This is due to current accounting rules under which banks only have to write down the value of securities in their portfolios if they decide to trade them on the market. Government bonds that they want to keep in their portfolios right up to maturity do not need to be written down.

Instead of exchanging ailing existing bonds for secure new ones with a lower face value, banks might instead speculate that the value of the bonds they possess could still be exchanged at face value when they mature. In the run-up to planned stress tests this spring with which the EU wants check how resilient Europe's banks are to a new crisis, the exchange of Greek bonds would not yield any advantages for many banks.

That would only change if regulators forced the banks to write down their bond holdings. "Without mild pressure from regulators, many banks will not comply with a voluntary exchange offer," says Thomas Mayer, chief economist at Germany's leading bank, Deutsche Bank.

Support in Berlin

Despite the risks it entails, the debt restructuring plan has a number of supporters in Berlin -- including, for example, the Council of Economic Advisors to Chancellor Merkel's party, the CDU. Council President Kurt Lauk is calling for a fresh start in euro rescue efforts that would include a European Monetary Fund and a stronger harmonization of economic policies in the countries that have adopted the euro. He believes that debt restructurings should take place as quickly as possible in Greece, Ireland and Portugal. "We need these three countries to make a clear move," Lauk says.

Clemens Fuest, a financial expert at Oxford University, is calling on politicians to take a more realistic view of the situation. "We need to accept the fact that Greece and Ireland are bankrupt," he says. Fuest believes there are only two ways to bring the crisis back under control: Either the financially strong countries must assume part of the debt of those countries in trouble, or creditors should forgive part of the debt. "But in that sense it would be better if the affected countries begin restructuring on their own."


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