Back in December I was lucky enough to meet Mitu Gulati, Professor of Law, Duke University, in Geneva. We both quickly concurred that the fiscal needs of Cyprus was in the agenda of all in Europe and beyond, and we decided to have a workshop about it in Nicosia. Lee C Buchheit, partner at Cleary, Gottlieb, Steen & Hamilton LLP, by far the most experienced sovereign debt reconstruction lawyer agreed to attend, and we decided to add a view from the ground by asking Fiona Mullen of Sapienta Economics to review the situation from Cyprus.
Lawyers are used to problem-solving and need to give their clients options: economists far too often retreat in the theoretical field when faced with a real world dilemma. Originally the plan was to present to excellent evaluation of the Eurozone debt crisis which was written by Lee C Buchheit and Mitu Gulati ("The Eurozone debt crisis- the options now" which in very simple language puts forth the possibilities of how the overall Eurozone debt issue will play out.
Yet thanks to Mitu Gulati's and Lee C Buchheit's incredible work-rate, they managed to make a working paper on the issue that was most on the mind of those who are considering restructuring of Cypriot debt: the issue of holdouts.
Mitu Gulati and Lee C Buchheit are intensely aware that in practical terms the Greek restructuring had a limited number of holdouts due to the fact that 93% of the Greek debt was under domestic law, and hence legal instruments could be retroactively integrated in the law to force the holdouts to settle. Yet Cyprus, as well as other EU countries, would face a significant holdout problem if they ever restructure their debt, even by mildly extending the maturity of the loan. This is because about half of the Cypriot debt was issued under English law, and because of that the investors have the ability to to holdout and demand to be paid in full and on time.
"The Problem of Holdout Creditors in Eurozone Debt Restructurings" spells out the problem; the authors offer an alteration of the Europe-wide ESM treaty that would reduce the bargaining power of the creditors, which has been noted by the Financial Times as a possible future issue to be addressed by the Eurozone member countries. My personal thought is that the Cypriot presidency, which took charge in the latter half of 2012 when the ESM was still not fully fleshed out, missed a historic opportunity to attach such a condition to the treaty. This would have helped Cyprus but also all other Eurozone nations struggling with their debt. Rather than chase the issues that were important for the Cypriot presidency in 2012, we chased the issues other presidencies seemed to have placed on the wayside. This is a minor error by the Republic when faced by another, more basic error: the fact that Cypriot government debt was issued without hiring lawyers to represent the republic. The decision of the Republic of Cyprus not to hire lawyers when issuing debt led to very inflexible contracts: in order to save some thousands of Euros in lawyer fees, the Republic now faces investor intransigence and the possibility of paying out billions of Euros that it can not afford.
The Workshop "Eurozone Debt Crisis:The options now, with Special Reference to Cyprus" took place on the 30th of January at the European University Cyprus and it was an unqualified success. Both English speaking and Greek speaking Cypriot media took up the concerns expressed by the three panellists (and echoed by myself, who acted as the moderator).
First up was Fiona Mullen of Sapianta Economics who in her presentation (you can access it here) outlined the current issues of Cyprus:
1) The republic is 2 to 3 bn Euro away from being able to call its debt "sustainable" and hence qualify for IMF assistance
2) There is a need to repay bondholders 1.4 bn euros in the 3rd of June, and the Republic does not have it.
Fiona argues that a mix and match of policies could bring the debt down to the IMF number of 120% debt to GDP ratio that is aimed by the IMF, and considers the idea of a very modest restructuring of the debt by extending the debt maturity by five years as one of the best options to alleviate the austerity of the adjustment period. Fiona is too polite to point out that that 2/3 Bn missing is because Mr Stavrakis (the then finance minister) decided to borrow short term rather than more expensive long term borrowing (that would have forced him to launch austerity or taxation increases). As a result over 34% of National debt is expiring in 2013 due to Mr Stavrakis' bet that the economic situation of Cyprus would have changed by the better this year. His lost bet doomed Cyprus: the amount we need to pay to bondholders that hold maturing debt is now the difference between being accepted as having a sustainable debt level by the IMF or not receiving a bailout. When the government rails against privatisation of semi-government companies, it is very ironic as its actions back in the period 2008-2010 ensured that some privatisation will be necessary.
Next, Mitu Gulati and Lee Buchheit divided their time on two issues:
1) The possibility of extending debt maturity in Cyprus: They pointed out that contrary to most shallow analysis, the Cypriot foreign debt contracts do have enough legal basis for Cyprus to go to court and expect a possibly favourable result (see the presentation here).
2) General Eurozone issues: Lee C Buchheit pointed out that the issue of Cyprus and the decisions if the EU taxpayer or the investor or depositors pay the price is now out of Cypriot hands.
The Eurozone has to decide not only in how to help countries which need bailouts, but also whether they want the debt liability to be the sole concern of the European taxpayer. Lee C Buchheit pointed out that out of the first Greek Bailout, approximately 75% of the bailout amount went to investors who were paid out in full, and the resulting political backlash led to a very severe haircutting of the remaining private investors. He suggests a more outright approach from the beginning as to who is going to bear the costs should be addressed at an Eurozone-wide level.
The discussion largely centred around Cyprus and what it could do. The general agreement seemed to be that if required, the pushing back of maturity of the existing debt seemed like the most sensible option. This re-profiling of the debt, rather than a haircut of the interest or of the principal could solve many issues:
- The reduction of the net present value of government debt owned by Cypriot bank would be relatively small, reducing the contagion to the local banking system.
- Thanks to the way contracts were written, even in the English law bonds there is enough of a difference of interpretation to ensure that the Republic has a chance in surviving litigation, thus changing the incentives of holdouts to accept the extension of the maturity.
- But the June deadline is very tight: in order to do the above the new president has to run and start the procedure of debt re-profiling, or at least convince the Eurozone partners to provide the amount needed to pay the June investors in full.
Lecturer, Economic History
European University Cyprus