terça-feira, julho 08, 2014

Debt workout 201 -

Six years into the crisis caused by the "credit bubble and bust", we continue to have a lot to learn about financial crisis management.     You can read about "credit games theory and practice"  in this PPP Lusofonia blog under "Debt Workout 101"  SEE

The concept of debt restructuring is simple, the devil is in details.  

Period 1 - Credit bubbles up. tsunami of money in-flows
Creditors A, B and C  (aka otherwise known as "foolish lenders") tare flooded with cash (because of lax monetary policy in the US,  because of enormous CAB current account surplus in Germany)  and are willing to lend at very low interest rates to " anyone",  "prime borrowers"  who will invest  well and payback and "subprime borrowers" who will use the loans to consumption (imported electronics and vacations) or will invest in things they don't need (second homes and empty roads) and thus will not be able to pay back.

NOBODY FORCES THE CREDITORS TO LEND,   that's why they are professionals well paid for their "credit risk" management skills.   

For example:  A borrower asked for a loan of 80.000 to buy a house, but the banks offer a loan of 120.000 to buy furniture, to buy a car, to take a vacation, and to pay a nice bonus to the lending officer for being so "good". 

Debtors X, Y, Z (aka "foolish borrowers") take all the loans that are offered to them and waste them on consumption or unproductive investments.  

To the extent scarce savings are misallocated, this is a failure of the intermediation function of the banking system and of banking regulation and supervision.  

Pediod 2 - Credit collapses

Debtors X, Y, Z  show first signs of being unable to repay short term loans, perhaps because no new creditor is willing to refinance loans as they come due. ( When I arrived in Mexico in 1982, I asked some borrowers to begin repaying, and a few weeks later, the whole country suspended payment) 

Creditors A, B and C realize they have been lending too much and  decide to cut lines of credit radically, demanding repayment  of short term loans as they come due instead of rolling them over as usual.  Long term lender become worried that borrowers will have nothing left over when their loans come due. 
In the US,  the long term lenders call a loan default and accelerate the repayment schedule to become pari-passu with the short term lenders, provoking a stand still and keeping all creditors in place. 
In Europe, the long term lenders arrange for third party official lenders of last resort (ECB or the TARGET2 system, to fund reimbursements of loans as they come due, avoiding default, preferably for a period of at least 5 years, which includes most of the loans. 

Period 3 - Credit workout renegotiation and restructuring 
Debtors X, Y, Z, if they are smart,  realize they cant' pay the 120.000 loan that they never really needed, and offer to repay 60.000, a bit under under initial borrowing capacity of 80.000    

Creditors A, B and C insist on repayment of the full 100.000, plus penalties, etc
After much hard negotiation, Debtors and Creditors  agree to a new repayment schedule, perhaps repaying 90.000 over 20 years with interest capped at 2%.  

A good and sustainable credit  workout  solution ALWAYS involves a sharing of the  the loss between what the creditor demands and what the borrower can pay  (120.000-60.000).   
This is the "business as usual 
When the negotiation power is too much in favour of he creditors,  and borrowers are forced to repay the full amount of the unsustainable and abusive credit, you have economic, social and eventually political disasters.  

When you fail to protect small local depositors and savers, but protect large cross-borders speculative investors, you have political disaster as well, and this is one of the major threats to the survival of the Eurozone and even of the European Union. 

It is unthinkable, and a radically violent precedent, that a Government not be able to reimburse small local investors in full on their so-called "risk-free" national public debt.  

In summary:  
1. Creditors should expect to take losses when they make bad loans to subprime borrowers 
2. Local depositors and savers should be able to expect full repayment of local deposits and "risk-free" national debt instruments in their own country.

See more about the Eurozone debt
workout  crisis in

Mariana Abrantes de Sousa 
PPP Lusofonia