Debt Restructuring 债务重组

 

Debt restructuring is a process used by companies to avoid the risk of default on existing debt or lower available interest rates. Individuals on the brink of insolvency also restructure their debt as do countries that are heading for a default on sovereign debt.

  • The debt restructuring process can reduce the interest rates on loans or extend the due dates for a company’s liabilities.
  • A debt restructure might include a debt-for-equity swap, in which creditors agree to cancel a portion or all of the outstanding debt in exchange for equity.
  • A nation seeking to restructure its debt might move its debt from the private sector to public sector institutions.

Some companies seek to restructure their debt when they are facing bankruptcy. A company might restructure several loans so that some are subordinate in priority to other loans. Senior debtholders are paid before the lenders of subordinated debts if the company files for bankruptcy. Creditors are sometimes willing to alter debt terms to avoid potential bankruptcy or default.

The debt restructuring process typically involves reducing the interest rates on loans, extending the dates when the company’s liabilities are due to be paid, or both. These steps improve the firm’s chances of paying back the obligations. Creditors understand that they would receive even less should the company be forced into bankruptcy or liquidation.

Debt restructuring can be a win-win for both entities because the business avoids bankruptcy, and the lenders typically receive more than what they would through a bankruptcy proceeding.

Ray Dalio, HOW THE ECONOMIC MACHINE WORKS:

Debt restructuring means lenders get paid back less or get paid back over a longer time frame or at a lower interest rate that was first agreed. Somehow a contract is broken in a way that reduces debt. Lenders would rather have a little of something than all of nothing. Even though debt disappears, debt restructuring causes income and asset values to disappear faster, so the debt burden continues to gets worse. Like cutting spending, debt reduction is also painful and deflationary. All of this impacts the central government because lower incomes and less employment means the government collects fewer taxes. At the same time it needs to increase its spending because unemployment has risen. Many of the unemployed have inadequate savings and need financial support from the government. Additionally, governments create stimulus plans and increase their spending to make up for the decrease in the economy. Governments’ budget deficits explode in a deleveraging because they spend more than they earn in taxes. This is what is happening when you hear about the budget deficit on the news. To fund their deficits, governments need to either raise taxes or borrow money. But with incomes falling and so many unemployed, who is the money going to come from? The rich.

Since governments need more money and since wealth is heavily concentrated in the hands of a small percentage of the people, governments naturally raise taxes on the wealthy which facilitates a redistribution of wealth in the economy - from the ‘haves’ to the ‘have nots’. The ‘have-nots,’ who are suffering, begin to resent the wealthy ‘haves.’ The wealthy ‘haves,’ being squeezed by the weak economy, falling asset prices, higher taxes, begin to resent the ‘have nots.’ If the depression continues social disorder can break out. Not only do tensions rise within countries, they can rise between countries - especially debtor and creditor countries. This situation can lead to political change that can sometimes be extreme. In the 1930s, this led to Hitler coming to power, war in Europe, and depression in the United States. Pressure to do something to end the depression increases. Remember, most of what people thought was money was actually credit. So, when credit disappears, people don’t have enough money. People are desperate for money and you remember who can print money? The Central Bank can. Having already lowered its interest rates to nearly 0 - it’s forced to print money. Unlike cutting spending, debt reduction, and wealth redistribution, printing money is inflationary and stimulative. Inevitably, the central bank prints new money — out of thin air — and uses it to buy financial assets and government bonds.

It happened in the United States during the Great Depression and again in 2008, when the United States’ central bank — the Federal Reserve — printed over two trillion dollars. Other central banks around the world that could, printed a lot of money, too. By buying financial assets with this money, it helps drive up asset prices which makes people more creditworthy. However, this only helps those who own financial assets. You see, the central bank can print money but it can only buy financial assets. The Central Government, on the other hand, can buy goods and services and put money in the hands of the people but it can’t print money. So, in order to stimulate the economy, the two must cooperate.

By buying government bonds, the Central Bank essentially lends money to the government, allowing it to run a deficit and increase spending on goods and services through its stimulus programs and unemployment benefits. This increases people’s income as well as the government’s debt. However, it will lower the economy’s total debt burden. This is a very risky time. Policy makers need to balance the four ways that debt burdens come down. The deflationary ways need to balance with the inflationary ways in order to maintain stability. If balanced correctly, there can be a Beautiful Deleveraging. You see, a deleveraging can be ugly or it can be beautiful. How can a deleveraging be beautiful? Even though a deleveraging is a difficult situation, handling a difficult situation in the best possible way is beautiful. A lot more beautiful than the debt-fueled, unbalanced excesses of the leveraging phase. In a beautiful deleveraging, debts decline relative to income, real economic growth is positive, and inflation isn’t a problem. It is achieved by having the right balance. The right balance requires a certain mix of cutting spending, reducing debt, transferring wealth and printing money so that economic and social stability can be maintained. People ask if printing money will raise inflation. It won’t if it offsets falling credit. Remember, spending is what matters. A dollar of spending paid for with money has the same effect on price as a dollar of spending paid for with credit.

By printing money, the Central Bank can make up for the disappearance of credit with an increase in the amount of money. In order to turn things around, the Central Bank needs to not only pump up income growth but get the rate of income growth higher than the rate of interest on the accumulated debt. So, what do I mean by that? Basically, income needs to grow faster than debt grows. For example: let’s assume that a country going through a deleveraging has a debt-to- income ratio of 100%. That means that the amount of debt it has is the same as the amount of income the entire country makes in a year. Now think about the interest rate on that debt, let’s say it is 2%. If debt is growing at 2% because of that interest rate and income is only growing at around only 1%, you will never reduce the debt burden. You need to print enough money to get the rate of income growth above the rate of interest. However, printing money can easily be abused because it’s so easy to do and people prefer it to the alternatives. The key is to avoid printing too much money and causing unacceptably high inflation, the way Germany did during its deleveraging in the 1920’s. If policymakers achieve the right balance, a deleveraging isn’t so dramatic. Growth is slow but debt burdens go down. That’s a beautiful deleveraging.

When incomes begin to rise, borrowers begin to appear more creditworthy. And when borrowers appear more creditworthy, lenders begin to lend money again. Debt burdens finally begin to fall. Able to borrow money, people can spend more. Eventually, the economy begins to grow again, leading to the reflation phase of the long term debt cycle. Though the deleveraging process can be horrible if handled badly, if handled well, it will eventually fix the problem. It takes roughly a decade or more for debt burdens to fall and economic activity to get back to normal - hence the term ‘lost decade.’ Of course, the economy is a little more complicated than this template suggests. However, laying the short term debt cycle on top of the long term debt cycle and then laying both of them on top of the productivity growth line gives a reasonably good template for seeing where we’ve been, where we are now and where we are probably headed. So in summary, there are three rules of thumb that I’d like you to take away from this:

  • First: Don’t have debt rise faster than income, because your debt burdens will eventually crush you.
  • Second: Don’t have income rise faster than productivity, because you will eventually become uncompetitive.
  • And third: Do all that you can to raise your productivity, because, in the long run, that’s what matters most.

This is simple advice for you and it’s simple advice for policy makers.