Commenter zhou_enlai raised the possibility earlier today of a debt buyback from the ECB. Such a buyback provides an interesting “third way” between the problematic bail–out strategy (new lending in the hope that some combination of growth/limited bank losses/primary budget surpluses will restore solvency) and the problematic bail-in strategy (restoring solvency through default).
There is an interesting literature on debt buybacks, with classic contributions following the Latin American debt crisis by Jeremy Bulow and Kenneth Rogoff (see, e.g., Bulow and Rogoff, 1988). They refer to buybacks as being a “boondoggle” for creditors. A key part of the argument is that when there is a high probability that creditors would not have got their hands on resources used for the buyback otherwise, the buyback provides an expected net transfer from debtor to creditors. However, others have argued that it is more likely that both sides can gain where there are large costs to default for the debtor. (See here for an excellent survey on the implications of sovereign default.)
In a potential Irish buyback, I think it is reasonable to suppose that creditors would have eventually got their hands the assets that would be used for a buyback (say the NPRF and the NTMA’s liquid reserves). But I think it is also reasonable to suppose that there would be a large cost to Ireland’s highly open economy from a default on ELG guaranteed bank debt or State bonds. Using the IMF’s fiscal space model, market participants have concluded that recent developments on growth and banking losses have eroded Ireland’s fiscal space. However, it might not take a large reduction in outstanding debt to restore sufficient space, significantly reducing the risk of a messy restructuring. Thus it is still possible that both sides could gain from a buyback despite creditors’ access to Irish resources.
One would think that the mechanics of a buyback could be reasonably straightforward with the ECB holding a significant fraction of Ireland’s outstanding debt. (Someone might be able to fill in an estimate of this number.) Just for illustration, a buyback of debt equal to 30 percent of GDP at a one-third discount would reduce the net debt to GDP ratio by 10 percentage points, possibly enough to restore enough fiscal space to ease creditworthiness fears.
There are of course potential legal issues to the extent bonds have covenants against such buybacks. But where buybacks are seen to benefit all parties, these restrictions do not appear to have been deal stoppers in the past. It would be good if those with knowledge of the legalities and other practicalities could weigh in. It certainly seems worth some debate.
Bulow, Jeremy, and Kenneth Rogoff. 1988. “The Buyback Boondoggle”, Brookings Papers on Economic Activity, No. 2, pp. 675-704.