How Chaotic Would an Italian Debt Restructuring Be? (Not Very)

Mark Weidemaier & Mitu Gulati

Wolfgang Munchau’s column in the FT yesterday identifies a possible Italian debt crisis as one of the biggest worries for the Eurozone. This makes sense, given Italy’s huge debt stock (upwards of 130% of GDP), seemingly irresponsible politicians, and low growth. An Italian debt restructuring would be the biggest in history, yet it might prove necessary. Munchau highlights the economic consequences of a debt restructuring (e.g., for Italian and other European banks) and also asserts that Europe’s “legal systems are not prepared.” The general sense is that an Italian debt crisis will be a disaster.

It won’t be good, that is for sure. But if planned properly, an Italian debt restructuring can be done relatively smoothly. Why? Because Italy has an enormous “local law advantage,” combined with an enormous set of captive (aka local) holders who have been, to quote an old friend in the sovereign restructuring business, “rolling over their Italian bonds since Hadrian died.”

One might ask, Didn’t Greece have the same local law advantage and wasn’t that a chaotic restructuring? Our reply is that the source of chaos in the Greek case was the unwillingness of key institutions to acknowledge that the debt was unsustainable until very late in the process. The restructuring itself was relatively smooth (for more, see here). In any case, the restructurers this time can learn from the Greek experience. Plus, the local law advantage is significantly bigger in Italy.

Students in our joint class on sovereign debt worked intensely this semester on what an Italian debt restructuring might look like, and they have recently posted their work to ssrn.com. From our informal conversations with European colleagues and friends, we understand that lawyers at various official sector institutions take the position that they do not have the power to do the things our students suggest. But we have yet to hear convincing reasons for this position. Indeed, our impression is that these lawyers are mostly worried that they will spook investors if they publicly acknowledge having the power to restructure (on the theory that investors might take this as a sign that restructuring is likely).

As background, recall that much but not all of Italy’s debt includes the new collective action clause (CAC) mandated by treaty in the Euro Area. It remains unclear whether CAC bonds will prove harder or easier to restructure. The problem is that the CACs are deeply flawed, yet we understand that many inside the Italian Treasury and Debt Management Office take the position that they must use the CAC if they are to restructure these bonds. We think that this is not correct; one of us explains why in “Restructuring Italian Debt: Do Euro CACs Constrain or Expand the Options?”

Next, our student papers: Each advocates a slightly different path, and one is exclusively about how to restructure the two NY-law bonds that Italy has outstanding. We think they are pretty cool and should be useful to whoever has to deal with the ultimate restructuring. This assumes, of course, that Italy doesn’t grow its way out of debt—a prospect that doesn’t seem likely given its history and the economic policies of its current government. Our friend Ugo Panizza has a super paper on the prospects of growth out of the debt debacle here – it is from 2015, but still very relevant).

We’ve organized our student papers under the perspective taken.

Unilateral reprofiling

Reprofiling Today for a Sustainable Tomorrow: A Unilateral Italian Debt Restructuring (Cervantes, Dodev, Ellement & Sawhney)

Buying Time: The Legal Case for Italy to Extend Maturities and its Effective Advantages and Disadvantages (Cramer, Saad & Thorpe)

Retrofitting new CACs

A Long Road To Nowhere: The Legal and Remedial Futility of Challenges to a Restricted Single-Limb CAC (Zellinger)

Single Limb Solution: Restructuring Italian Debt (Harrington, Klabo & Pita)

Using the existing CACs

Why Reinvent the Wheel? Restructuring Italy's Debt Using the Euro CAC (Buchta, Plambeck, Shan & Shufro)

New York law bonds that many thought impossible to restructure (perhaps incorrectly?)

Restructuring Italy’s New York Law Bonds (Kropp)