Financial engineering for the common good

The exact details of Greece's debt restructuring proposals remain unknown (perhaps even to the Greek government itself). But the core of the proposal - swapping the rescue loans for bonds linked to Greek GDP - has received a lot of commentary, almost all of it positive.

A GDP-linked bond would make the payments due by Greece conditional on the economy's growth. It could, for example, pay nothing in years of low growth. Payments would start when growth, or GDP, reaches a certain level and rise the stronger the recovery becomes. The creditors' claims would, in other words, become linked with Greece's economic fortunes. As Greg Ip points out, this amounts to converting debt into equity, a common and straightforward operation in corporate finance. Martin Wolf supports the idea as it aligns the interests of Greece and its creditors by sharing the risk.

Professional economists like the idea too, and have for a while. The IMF has recommended it for more than a decade and produced work on how to price GDP-linked securities. The Bank of England published a paper last year concluding that "significant welfare gains can be achieved by indexing debt to GDP". The solution has been analysed and advocated specifically for Greece by several European research institutes. Marcel Fratzscher and his colleagues at the German Institute for Economics Research did so last year. Bruegel's Zsolt Darvas thinks the current proposal is a major step towards a compromise with Greece's creditors.

In other words, the supposedly revolutionary Syriza has come up with a sensible idea that its European counterparts should take seriously. So far, though, they are not biting. What's not to like about the debt-swap plan? Paulo Mauro at the Peterson Institute, while supportive of GDP-linked bonds, considers some objections. One is, of course, that since future growth is uncertain, so are the payments on bonds linked to it. Why would creditors accept this without compensation? Is it not a debt writedown in all but name? The answer is that the repayment of the existing loans is already highly uncertain - or even certainly not going to happen. The creditors' choice is between getting nothing if things go badly and a limited amount if they go well, and getting nothing in bad times and much more in good ones than with the current loans.

The most convincing objection, pointed out by both Ip and Mauro, is that if payments are linked to GDP, then they are linked to how GDP is measured. No one questions Iceland's GDP-linked discharge of payments related to the Icesave banking collapse; many question how Argentina's fudged official statistics have affected that country's GDP-linked obligations arising from its 2001 default. Here, Greece's bad reputation works against it. But accurate GDP statistics are something the EU needs anyway. And since Eurostat refused to sign off on Athens' accounts in 2010, a lot of work has gone into improving statistical practices. In this matter, at least, Greece has made a considerable move from Argentinian to Icelandic habits.

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