What Does Debt Restructuring Mean?

Individual, corporate and government entities carry short- and long-term debt. Individuals have home mortgages; corporations issue bonds to finance growth plans; and governments issue debt to pay for services. When economic and business conditions worsen, these entities can have trouble meeting their debt obligations. Debt restructuring helps them lower these payments to manageable levels.

Individual Debt Restructuring

Individuals need debt restructuring when their monthly income is insufficient for the interest and principal payments on the debts they owe. If interest rates are low, mortgage refinancing could reduce the monthly payments and improve cash flow, suggests Tom McFeat, a business news producer at the Canadian Broadcasting Corporation. Converting some of the high-interest credit card debt to lower-interest debt could also reduce monthly payments. Another restructuring option is a consolidation loan, wherein high- and low-interest debt are combined to reduce the overall monthly payments.

Corporate Debt Restructuring

Corporate debt includes short-term loans and long-term bonds. Debt restructuring is required when adverse business conditions reduce a company's debt-servicing ability. Thomas Laryea, assistant general counsel at the International Monetary Fund, suggests a two-pronged restructuring approach, especially after a financial crisis: Sick firms should be encouraged to gradually wind down their operations, and the rest should be provided debt restructuring assistance and timely access to financing. Corporate debt restructuring may include rescheduling debt payments and swapping debt for equity. Laryea suggests that operational restructuring, such as layoffs and expense reductions, should accompany debt restructuring to improve cash flow and reduce the overall corporate debt.

Sovereign Debt Restructuring

The debt of national governments, known as sovereign debt, sometimes requires restructuring. Examples include Greece (2010), Iceland (2009-2011) and Mexico (1995). Former World Bank chief economist Anne O. Krueger, quoted by economy policy think-tank Financial Policy Forum founder Randall Dodd, suggested a four-step sovereign debt restructuring program: First, a majority --- not unanimity --- of the creditors approves any restructuring plan. Second, a temporary stay is placed on creditor enforcement actions once debt payments are suspended but a restructuring agreement has not yet been reached. Third, creditors receive assurances that their interests are being protected --- the sovereign debtor must not make payments to non-priority creditors, and must demonstrate that asset values are being protected. And fourth, private financing is arranged during the stay period for such things as trade credit for export/import activity, and payments to priority creditors.

Considerations: Government Intervention

During times of severe financial distress, government intervention is often needed for debt restructuring. After the 2008 financial crisis, for example, U.S., Canadian, British and other governments around the world intervened aggressively to shore up corporate balance sheets, take over and restructure failing companies (e.g., General Motors) and even help individuals restructure some of their mortgage debt. Laryea suggests a few drawbacks in these interventions: the existence of "unproductive zombie" companies supported by taxpayers, and unnecessary risk-taking by management confident of a government bailout in the event of a failure.

References

• Canadian Broadcasting Corporation; Dealing With Debt; Tom McFeat; September 2006
• International Monetary Fund; Approaches to Corporate Debt Restructuring in the Wake of Financial Crises; Thomas Laryea; January 2010
• International Monetary Fund; A New Approach to Sovereign Debt Restructuring; Anne O. Krueger; 2002