Greece and Germany are heading at each other at high speed, fundamentally disagreeing about Greece’s need to stick to the austerity provisions in its loan agreements. The question is whether either will turn off at the last second. Domestic political concerns in both countries argue against it.
Greece’s proposal to swap its European Union debt for “growth bonds” harks back to the Gilded Age, when J.P. Morgan (the man) and his attorneys from Cravath restructured insolvent American railroads by the dozen.
One common move in the railroad receiverships was to swap defaulted bond debt for income bonds. Income bonds entitled the holder to a percentage of the railroad’s net income over certain thresholds.
Thus, the fixed interest payment on the old bonds was replaced with a contingent payment. That solved some of the railroads’ cash flow problems.
The Greek proposal seems to be quite similar — although it is a bit light on details — replacing fixed interest payments with payments contingent on the Greek economy exceeding certain targets.
The hitch is that the railroad receiverships of the late 19th and early 20 centuries were often unsuccessful, since the failed railroads often failed again. In a paper a while back in the Cornell Law Review, I argued that the railroads were still left with too much old debt, which impeded their ability to obtain new financing.
That is, reducing fixed charges is nice but not sufficient to start anew.
Greece has to worry about the same thing.
It is a neat trick to try to overcome the resistance to Greece writing down its debt — a “haircut” — with contingent debt. But contingent debt is still debt, and someday it will come due. Potential new lenders know that.