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Dealing with debt: Defaulting, restructuring, reprofiling

Marketplace Staff Jun 2, 2011

Dealing with debt: Defaulting, restructuring, reprofiling

Marketplace Staff Jun 2, 2011

Jeremy Hobson: Well one of the things that’s been most worrying to global investors in recent weeks and months has been the debt crisis in Europe. And it just got worse.

Last night, the ratings agency Moody’s cut Greece’s credit rating again and said the country now has a 50 percent chance of defaulting on its debt in the next five years.

As for the U.S., well if Washington doesn’t make a deal we could default on our national debt in the next two months.

Let’s bring in our economics correspondent Chris Farrell to help explain some of the terms that people are throwing around when it comes to this debt debate. Chris, good morning.

Chris Farrell: Good morning Jeremy.

Hobson: Well why, Chris, if we miss a payment on the national debt, are we defaulting? Can’t we just have a late payment?

Farrell: Well you could, but look: you’ve broken the terms of the loan. But the real question is: what’s the context? If you miss a payment on your mortgage or the rent, you just write a check the next month, pay a fee — no big deal.

Hobson: Right.

Farrell: But what if you’re Greece, and your debt is 150 percent of the economy — it’s on its way to 160 percent of the economy — and most investors believe they can’t continue to make those payments? Default becomes serious.

Hobson: So they think that you just won’t be able to make any future payments if you can’t make one?

Farrell: Under the current terms of the loans.

Hobson: What about restructuring debt? That gets talked about a lot — what does that mean?

Farrell: This is the important subject, because that means they can’t make their payments under the current loans — let’s change the terms of those loans. So one way you could change the terms of the loans is say, you could owe us less. All right, we’ll just reduce the interest rate, we’ll reduce the overall amount that you owe us. That’s a restructuring. You could also change the terms alone by extending the length of the loan. Think about a student loan. You have a 10-year repayment, you run into trouble, you extend that out to 20 years. You lower your monthly bill at the cost of increasing the overall price of the loan over time, but that’s a restructuring. That’s also on the table.

Hobson: OK, so that’s restructuring. But in Greece, they are talking about debt reprofiling. What does that mean?

Farrell: A reprofiling is a type of restructuring. Simply put, you take your loans and you make them much longer. You push them out, but you keep the overall value of that debt the same. And therefore, the banks don’t have to say, we took a loss.

Hobson: Marketplace economics correspondent Chris Farrell, thanks for clearing it all up for us.

Farrell: Thanks a lot, Jeremy.

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