A Debt Restructuring Mechanism for Sovereigns

Do We Need a Legal Procedure?

Christoph G Paulus

• Publisher: Hart/Beck
• Year: 2014
• ISBN:
  9781849468206
• Edition: 1
• Topic: Law
• Subtopic: Bankruptcy & Insolvency Law
• Index: Law

The Eurozone crisis which started in spring 2010 as a Greek budget crisis has alerted Europeans that the issue of defaulting sovereigns is not one reserved just for the poor and poorest countries on this globe. The crisis painfully amplified that developed countries, too, might be hit by this phenomenon. To be sure, this insight is far from novel - the history of defaulting states reaches back into history for at least two millennia. And yet, lawyers have surprisingly abstained more or less completely from discussing this subject and developing possible solutions. Beginning with the Argentina crisis in 2001, this neglect began to vanish to a certain degree and this movement got some momentum in 2010 by the Eurozone crisis. The present book collects contributions from authors most of whom have participated in a conference on this issue in January 2012 at the Humboldt-Universität zu Berlin. The presentations, thus, provide a unique overview of the present discussion both from an economic and legal perspective.

Chapter 1:
The Historical Experience and Economics of Sovereign Debt

A. Echoes of History: The International Financial Commission in Greece

Dr. Michael Waibel^*

1 From Edward Law Street in central Athens, one can catch a glimpse of the Acropolis in the distance and overhear the protestors camped out in Syntagma Square. Named after Major Edward Law, this street reminds us that external interference in Greek finances is nothing new. Major Law, as the first President of the International Financial Commission of Control of Greece, achieved the seemingly impossible at the end of the 19^th century. He helped, in his role as the first President of the International Financial Commission (IFC) that was established in 1898 at the insistence of Greece’s creditors, to return Greek finances to debt sustainability and a sense of normalcy, albeit only temporarily.

2 Five years earlier, Major Law had spent four months on behalf of the British government in Greece to survey Greek public finances. Though initially greeted by a hostile local press, Law soon earned the admiration and gratitude of the Greek people.¹ His hard-hitting Report on the Economic and Financial Position of Greece singled out high military spending, excessive borrowing abroad and inadequate tax administration as the principal causes of the Greek financial difficulties. Despite these shortcomings, he predicted a bright economic future for Greece.² His report temporarily restored confidence in Greek credit.³ When he died in 1908, Law was buried in Athens in a procession that resembled a state funeral – such was the admiration that his work elicited among the Athenian political class and ordinary Greeks.⁴

3 How did Major Law become such a central player in Greek history? This chapter examines the rise and fall of the International Financial Commission in Greece (“the IFC”), set against the background of Greek public finances in the 19^th century. As the most influential negotiator who worked on the Law of Control that created the IFC, and its first President⁵, Law laid the groundwork for the IFC’s operations for the next five decades. The IFC played a central role in Greek economic life up to and throughout the interwar period. The peace agreement in respect of the war over Crete between Greece and the Ottoman Empire provided the foundations for the establishment of the IFC.

Greece defaulted for the first time on the two independence loans of 1824 and 1825 to London banks shortly after independence. The first section covers the war of independence against the Ottoman Empire (1821–1832), the first Greek default in the 1820s, embryonic attempts by the creditors of Greece to oversee debt repayment and the events in the lead up to the Greek default in 1893. In conjunction with the 1887 Monopoly Loan to Greece, Greece and its creditors established the Société de Régie de Monopoles de Grèce whose task it was to collect and supervise the movement of all funds from the revenues assigned for debt service.

I. Greek independence in 1832 and borrowing abroad

From 1458–1832, Greece formed part of the Ottoman Empire. Between 1821 and 1833, the Greeks rebelled and fought for their independence, and successfully seceded from the Ottoman Empire in 1827, though it took until 1832 for independence to be fully achieved. The first Greek revolt against Ottoman rule took place on 23 March 1821. Ten months later, the National Assembly proclaimed the independence of Greece.

Throughout the 19^th century, Greece was a central staging ground for the foreign policy designs of the major European Powers. Foreign policy considerations, but also philhellenic feelings among the political and intellectual elite⁶, led the major European powers to financially support Greece in the early years after independence.

Great Britain in particular was a strong supporter of Greek independence, but was at the same time concerned that an independent Greece may fall under the sway of France or Russia, or both. To Britain, Greece was her foothold in the Mediterranean, acting as a counterweight to Russia’s ambition in the region. The remaining European powers, still exhausted from the Napoleonic wars, initially hesitated to support the Greek insurrection, against the recent memory of the French Revolution. The support of European powers ranged from military intervention, over diplomacy to financing for the fledgling Greek state. The sole major European power to oppose Greek independence was Austria.⁷ However the price Greece paid for this financial and political support to free itself from Ottoman rule was long-term political dependence on the European powers.⁸

The London Greek Committee took up the Greek cause in Britain and Blauqiere’s exaggerated report of 1823 on the economic prospects of independent Greece excited investors.⁹ Lord Byron, one of the leading advocates of Greek independence as a member of the London Greek Committee, remarked that Britain’s ‘true interests are inseparably connected with the independence of those nations, who have shown themselves worthy of emancipation, and such is the case with Greece.’¹⁰ At the time, interest rates on British government debt were low, and the high yields offered by lending to insurgent Greece were attractive. On the advice of the London Committee, Greece sent a delegation composed of Orlando, Louriotes and Zaimes with the power to contract loans.¹¹

From 1821 onwards, the Greek insurgents had sent delegations to several European capitals with a view to procuring funds for their fight for independence. Initially, these efforts failed. In its first official act on 23 November 1821, the Greek National Assembly already approved a foreign loan. Baron Theochary, Kephala Olympios and Chroni Drossinos were authorized to borrow 150,000 florins of Augsburg on behalf of Greece.¹² In 1822, the Greek National Assembly authorized its delegation at Ancona in today’s Italy to negotiate a loan for up to 1 mln. Spanish dollars. As security for the loan, the Assembly pledged all lands held by the insurgents. Austrian Chancellor Metternich, however, opposed Greek independence out of concern that a Russo-Turkish war would inflame evolutionary activity across Europe and endanger the status quo of European balance of power encapsulated in Congress of Vienna’s settlement. Metternich’s strong opposition doomed the Italian loan, and the Greek delegation returned home empty handed.¹³ In 1824, Napier, a British military officer posted to Greece who also acted as military advisor to the Greek insurgents approached the Greek London Committee for a loan of €40,000 to equip the Greek forces (which he aspired to command) against the Ottoman Empire, but the Greek National Assembly failed to authorise such borrowing.¹⁴

Potential lenders also approached Greece, and peddled dubious schemes to finance the Greek insurgents. The Knights of Malta were a particularly curious example. They hoped to convince France that the resurrection of their moribund order would serve French commercial interests in the region. The knights signed a loan contract and a treaty of alliance with the Greek insurgents. The price for this financial support was that Greece would be required, upon independence, to cede the island of Rhodes in perpetuity to the Knights.¹⁵ Unsurprisingly, the proposed loan fell on deaf ears in France.

In February 1824, two years into the war on independence, Greece finally managed to borrow €800,000 from Loughman, O’Brien, Ellice & Co, a London bank.¹⁶ The Greeks viewed the first independence loan as a ‘financial triumph’ and as international recognition that independence was imminent.¹⁷ From the perspective of the lenders however, such loans to insurgents carried high risks. Lenders could only ever hope to be repaid if the insurgents succeeded, and even then, as the Greek case shows, they might suffer significant losses due to defaults.

The issuing price of the first independence loan in 1824 was €59, with interest of 5 % on nominal capital and 1 % on sinking fund.¹⁸ This price translated into only €472,000 of net funding (59 %) to Greece, though on maturity Greece was obliged to repay the entire €800,000 – a common practice in the 19^th century that encouraged over borrowing.¹⁹ On top of this 39 % discount, the London bankers withheld a further €123,000 (15 %) as negotiation and commission expenses and interest and sinking fund charges for the next two years.²⁰ The Greek government received only €348,000 (44 % of the principal) as a result. The loan also marked the beginning of financial mismanagement by the Greek government.

In early 1825, Louriotis, now looking for funds in France, negotiated a 20 mln. francs loan with the Parisian bankers Cottier and Odier. Soon thereafter, he learnt that Orlandos and Zaimis in London had already signed a loan agreement with Jacob & Samson and Ricardo in London for €2 mln. The terms of the British loan stipulated that no other lending was to take place in the same year – which meant that Greek insurgents had to choose between the French loan and the second British loan. The Greeks opted for the cheaper British loan with an interest rate of 5 %, and backed out of the French loan. The price of issue of the latter was €55.50, and hence offered an even more attractive yield than the first independence loan of 1825. The sum realized was 1.1 mln., with €816,000 effectively available to Greece, or 40 % of the principal of the loan.²¹

“All revenues” and “the whole of the national property of Greece” were pledged as security for the 1824 and 1825 loans. Both loans contained an identically worded security clause: “To the payment of the Annuities are appropriated all revenues of Greece.” “The whole of the national property of Greece is hereby pledged to the holders of all obligations granted in virtue of this Loan until the whole amount of capital, which such obligations represent, shall be discharged, and to effect which a Sinking Fund will be provided.”²²

Importantly, the two independence loans already provided for substantial oversight of the lenders over the use of the funds. The London Committee and Jacob & Samson and Ricardo appointed a Board of Control to oversee the use of the two pre-independence loans. The members of the Board were S. Ricardo, J. Hobhouse, E. Ellice and F. Burdett, who in turn appointed three resident commissioners in Greece to act as an advisory body. The Committee and its resident commissioners were tasked with acting in the best interest of Greece, and not only act as agent for the lenders. They had the power to supervise and suspend the disbursement of funds.

In its practical operation, however, the Board fell considerably short. The Board used more than €200,000 of the proceeds of the first loan to artificially prop up prices of Greek debt, with a view to unload Greek debt held by insiders.²³ Some of the proceeds were used to construct new naval ships, though the construction proceeded too slowly to be of any help in Greece’s fight for independence and was moreover marred by mismanagement and corruption.²⁴ The English press severely criticized the board for greed and incompetence in light of these irregularities.²⁵

On 6 July 1827, France, Great Britain and Russia signed the Treaty of London, and formally called upon the Ottoman Empire to cease hostilities against...