A smarter way for countries to restructure their debts
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Illustration: Aïda Amer/Axios
When companies are feeling rich, they buy back their shares. Similarly, when some countries find themselves with more money than they expected, they should buy back their bonds, per a new paper from sovereign-debt experts Lee Buchheit and Greg Makoff.
Why it matters: Such a mechanism, if enshrined in bond documentation, would finally allow the borrower to see some benefit from making extra payments.
The big picture: When countries default, they generally exchange their old bonds for new ones that have a lower face value or longer maturities.
- The amount that the country can afford to pay in debt service six or more years down the line, however, is little more than "an exercise in occult divination," as Buchheit puts it. (Buchheit generally has co-authors, but certain parts of his papers are unmistakably him.)
- Creditors who participate in the restructuring therefore often require some kind of value recovery mechanism that will allow them to receive more money in the event that the country's economy ends up booming.
The catch: Those mechanisms are generally valued at or near zero at the time of restructuring, and they don't help the country at all if and when they ever kick in.
- "The payments do not buy anything; they do not reduce any liability of the sovereign; they do not service the sovereign's debt; they often do not even reward the institutions that supported the sovereign in its time of need," write the authors.
How it works: Buchheit and Makoff propose that instead of countries just wiring extra money to bondholders, they should use that money to buy back their bonds, starting with the longest maturities.
- If the bonds are trading below par, that means an immediate capital gain for bondholders.
- The remaining bonds will have a lower average maturity, and therefore will be worth more, assuming a normal upward-sloping yield curve. There will be a lower supply of debt outstanding, which will also serve to increase values.
- In all, the value for a mark-to-market bond investor should end up being higher than they would have received from a simple cash payment.
The other side: From the borrower's perspective, the prepayments improve the sovereign's debt dynamics and lower its borrowing costs.
The bottom line: A restructuring system that benefits borrowers as well as creditors — and that is less prone to litigation — is more attractive than the current system, which based on weird constructs like GDP warrants.
