Writing-Down Debt with Heterogeneous Creditors: Lock Laws and Late Swaps

The presence of “holdouts” in recent sovereign debt swaps poses a challenge to bargaining models which assume all creditors to be homogeneous. We modify the Rubinstein “alternating offers” framework so as to accommodate exogenous creditor heterogeneity – specifically holdouts more patient than other bondholders. The “second best” equilibrium derived is an initial offer and an associated “lock-law” sufficient to tempt impatient creditors into a prompt bond exchange. This is followed by a delayed, but more generous, swap with the patient creditors, timed to take place when the lock-law expires. In practice, however, the presence of holdouts may be endogenous: they may be late-comers who buy distressed bonds with a view to litigating for the full face value plus their costs of waiting. Provisions for protecting other bond holders from the negative externality caused by such tactics are briefly discussed. However, where the judge has mandated good faith bargaining with holdout creditors, the bargaining outcome we derive may be useful to indicate a basis for compromise.