The Full Brady

Financial markets are increasingly certain that a Greek debt restructuring is coming. Fortunately, there is a way to avoid the worst: emulate the Brady Plan, under which commercial banks, together with official creditors, restructured and took haircuts on the debt of Latin American and Eastern European governments in the 1980’s.

BERKELEY – Financial markets are increasingly certain that a Greek debt restructuring is coming, and European policymakers fear the worst. “In the worst case,” as Juergen Stark, a member of the European Central Bank board, has put it, “a debt restructuring of a eurozone member could put the consequences of Lehman’s bankruptcy in the shade.”

But there is also a best-case scenario, where Greek debt is restructured in a way that doesn’t threaten the banking system.

The simplest way to achieve this would be to require banks exposed to southern European debt to raise more capital. The second round of stress tests by the European Banking Authority is ostensibly designed with this end in mind. By showing who is weak and who is strong, proper stress tests would also limit counterparty risk. Lenders would have good information about whom to do business with – and whom to shun.

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