January 24, 2011
Paul Krugman's link (and old paper) reminded me I had wanted to cover this idea:
Analysts said on Wednesday that having Greece buy back its own devalued bonds could be an important step toward solving Europe’s sovereign debt crisis.
It's an interesting equilibrium. Let's say Greek bonds are selling for 60 cents on the dollar. If the Greek government offers sixty-one cents, arguably the government is signaling a more optimistic prognosis than a 60 cent value or even a 61 cent value for the bond. Don't sell ("beware of Greeks bearing gifts!"). If everyone is a rational Bayesian, the price of bonds should go up to the point where the Greek government doesn't want to buy the bonds any more or where indifference holds.
If buying back some of the bonds makes the rest of the debt easier to pay back, all the more reason not to sell your bonds at the initial offer price.