Managing Deep Debt Crises in the Euro Area: Towards a Feasible Regime

Abstract

In spite of the inclusion of collective action clauses ('euro-CACs') in euro area sovereign bond contracts since 2013, the euro area still does not have a credible debt restructuring framework because: (1) stability risks of debt restructurings remain high; (2) euro-CACs make it easy for creditors to hold out for full repayment; (3) IMF lending policies have not prevented the bailout of countries with unsustainable debts. In reaction, some proposals have called for hard criteria requiring debt restructuring as a condition for access to official crisis lending. This paper argues that this is the wrong approach, because hard criteria are error-prone, may trigger crises in high-debt countries, and lack credibility when the economic costs of debt restructurings are high. Instead, the key to a credible debt restructuring framework is to reduce these costs, by cutting the links between sovereigns and banks and putting safety nets in place that limit contagion. Policy Implications• Modify bank regulation to discourage euro area banks from holding concentrated exposures to individual euro area sovereigns.

The Price of Law: The Case of the Eurozone Collective Action Clauses

“…9 As of this writing, in 2020, policy makers in the Euro area are considering enhancing the effectiveness of the existing CACs in Euro area sovereign bonds starting in 2022, so as to further reduce the likelihood of holdout problems in future debt restructurings. Some EU members are however resisting this reform, on the grounds that making it easier for sovereigns to restructure will raise their cost of borrowing at an inopportune moment (Zettelmeyer (2018)).…”

The benefits of reducing holdout risk: evidence from the Euro CAC experiment, 2013–2018

“…The economic dislocation accompanying sovereign debt defaults worsens the longer it takes debtors and creditors to find a negotiated solution (House et al, 2017;Schumacher et al, 2018). 1 History shows that rogue creditors (also known as hold-out creditors) have often blocked restructuring processes, making these unnecessarily protracted and painful (Aguiar and Amador, 2014;Zettelmeyer, 2018). In reaction, the international community has over time developed tools to minimize the costs created by these hold-out creditors.…”

“…Given that double-limb aggregation may not prevent bondholders from obtaining blocking positions in specific bonds, there is an ongoing debate within the euro area regarding the convenience of adding ICMA-like CACs to the documentation of sovereign bonds (Zettelmeyer, 2018;Andritzky et al, 2018). Those in favour argue this would reduce uncertainty and provide incentives to buy these bonds.…”

Stabilisation policies to strengthen Euro area resilience

“…In other words, the aggregation feature may not be sufficientand it is indeed weaker than the mechanism applied in the 2012 Greek debt restructuring where all domestic law bonds were subject to a single vote (Gelpern at al., 2015). Stronger aggregation rule allowing for a single vote across all debt instruments affected by a restructuring (the so-called "one-limb" voting) could considerably streamline the process, as it would make it much harder for potential holdouts to acquire a stake that could block a restructuring (IMF, 2014;Zettelmeyer, 2017). Other measures addressing the weaknesses of the one-limb voting would include a provision ensuring that all creditors are offered identical restructuring terms (Andritzky et al, 2016b).…”