Popular but drastic step could drive money away and freeze bank credit
Published 27/11/2010 | 05:00
ASK any man on the street if he wants bank bondholders to 'share the pain' of Ireland's financial collapse, and the reply is likely to be a resounding yes.
There are a few other ways of asking the question though.
Like, do you want people to be scared to put money in Ireland's banks in case depositors become the next frontier for pain-sharing?
Or, do you want to put Ireland's banks in a position where they'll be locked out of the international money market for a decade?
Or, do you want the country's already-fragile economy to be crippled by an obliteration of consumer credit?
Because if we go down the route of burning bondholders who thought their money was as safe as deposits, all of the above could very well come to pass.
And that's before taking account of the shockwaves that would reverberate across the European banking market and further.
The attractions of burning bank bondholders are obvious. For a start, if we made them accept discounts of even 10pc we'd save €8bn, according to figures from stockbrokers NCB.
That's €8bn that could be spent on schools, hospitals and other vital public services. Enough money to wipe out the horrendous impact of 2010's Budget in one fell swoop, and have a few billion left in change.
Then there's the fairness argument. Those who bought bank bonds are stakeholders in the collapsed banking sector -- they should be made share the tab instead of passing it all on to the Irish taxpayer. It's only fair.
The dangers of burning the bondholders are less obvious, but they're massive all the same.
The senior bondholders the IMF and EC apparently want to burn are the investors who took relatively low rates of interest in exchange for the knowledge that their money was as safe as if it were in a deposit account.
Irish law explicitly gives senior bondholders the same status as deposit holders. Our international visitors are apparently trying to find legal structures to get around this challenge, but market sources say it makes no difference -- burn the senior bondholders and you've torn up the contract with depositors as well.
"Who's going to put money into an Irish bank then, when they know they're only safe until someone changes the rules?" as one international trader puts it.
Fry the senior bondholders, singe them even, and the steady trickle of deposits leaving Irish banks could well become an avalanche.
Irish banks have already lost more than €36bn of deposits this year, but they've tens of billions left to lose.
Depositors aren't the only ones who would be horrified to see senior bondholders in the firing line.
The banks' trade creditors, mainly other financial institutions, are also granted equal status to senior bondholders by Irish law.
"Who is going to want to do an interest rate swap with an Irish bank when they know they could end up not getting all the money?" asked one expert.
"Who is going to want to lend Irish banks any money at all?"
Debt traders say Irish banks could be locked out of the markets for as long as a decade.
The result would be a banking sector 100pc dependent on money from the European Central Bank or some other form of non-market support.
Such a landscape is not likely to be kind to the Irish consumer.
"The banks would be forced to shrink their balance sheets," said one source. "There would be an enormous domestic credit crunch and people would find it hard to borrow money for a very very long time."
The man on the street might want to think twice before signing up for that.