Thursday 27 November 2014

We will default, so let's get on with it

But it's not all bad -- a top financier thinks Ireland's glass is half full and our bank debts will be shared, writes Daniel McConnell

Published 05/06/2011 | 05:00

Ireland will default, when it does happen we should not do it alone but with Greece and Portugal; we should consider leaving Europe given how badly they treat us; we need to take a scalpel to our public sector and Ireland will take five to seven years from now to recover.

Those are the views of Larry McDonald, former Lehman Brothers vice president turned international best-selling author, who was in Dublin last week speaking at the Irish Funds Industry Association.

McDonald was, until September 2008, vice president of distressed debt and convertible securities trading at Lehman Brothers. He was heralded by many colleagues at Lehman for both his early 2006 call on the subprime crisis and the $46m in trading profits realised from it.

I sat down with him on Friday afternoon last in the heart of the IFSC to discuss his take on Ireland's future. And while his stark outlook may shock many, his candid, no-nonsense pronouncements are exactly what we need to see more of from our Taoiseach Enda Kenny and his government ministers.

A respected commentator internationally, McDonald, who predicted the sub-prime crisis in the US, had just come from a meeting with Central Bank Governor Patrick Honohan, who he described as "quite the poker player," when we met.

I began by asking him the biggest question. Will Ireland default or not? He was unequivocal in his answer.

"When you look at the way the bonds are trading, there will be haircuts [debt write downs], absolutely."

"These haircuts, which are called forbearance, is essentially extending the maturity. It's a technical default, but it's not a hard default."

Given Ireland's huge and unsustainable debt mountain, the market clearly believes some form of an Irish default is inevitable, he says.

"The subordinated bonds at the Bank of Ireland, which is an obligation of the State, of the Government, was trading at 55 cent in the dollar to this week 30 cent in the dollar. So there will be some haircuts, and there will be some pain there."

But what will that do to investors looking at Ireland?

"No doubt, that will scare the institutional investors, and that will scare the markets so we [Ireland] are in for some choppy waters."

He went on to explain that when the default happens, those institutional investors will immediately be scared away from Ireland, for a period of time, but he said the fallout would not be as bad as many are predicting.

"There may be haircuts around and across the eurozone, it's not going to be as bad as people think. If there are haircuts around the EU, it will shock the markets, there will be choppy waters, but it's not like Ireland will be the only one. I think Portugal and Greece and some others too possibly."

So I ask him to clarify, should Ireland seek to default with others or should we go it alone? Again, he is in no doubt. "Ireland should never default by itself, it should be part of a coordinated approach with other EU countries."

Since taking office, Kenny and his Government have revealed a shocking inability to distinguish themselves at European level, reflected in their failure to yet secure a better interest rate on the bailout or any major concessions to the deal itself.

Kenny and his government seem unwilling or unable to face up to the bully-boy tactics of Angela Merkel and Nicolas Sarkozy and the deeply abusive treatment of Ireland by the ECB.

McDonald agrees with my assertion that Ireland is being treated very badly by our European partners, and concurs that leaving the euro should be considered as a viable option.

"I think Ireland leaving the euro/Europe should be on the table for consideration. The powerful wealth creation of growth of an Irish currency that's weak compared to eurozone, would provide a lot of stimulus over time. The structural problem is leaving the euro is a five-year project," he said.

McDonald was also scathing in his critique of our public finances position and our system of "insane" welfare benefits.

"I have sat down with some pretty influential people this week and it seems there is a lot of fat to be cut. I know people don't want to hear that. The entitlements here are so much greater than they are in the United States."

McDonald's view echoed that of OECD economist, Patrick Lenain, who said he knew of no other country where more people received unemployment benefit than there were unemployed people.

He added: "This allowance for child, the child benefit, when there is no means testing. That's insane. Insanity. there is nothing like that in the US. Say you get a guy who earns €400,000 a year, and he is going to get €40,000 in benefits. Insane. If you cut that, there's €200m right there."

He called on the Government to be courageous and tackle the vested interest of the public sector to eliminate the fat.

"In every economic cycle, there are cuts and expansions. There has to be cuts in the public sector, the problem is that the public sector here in Ireland have the votes," said.

On the positive side, McDonald said that Ireland has the necessary tools to recover the ground and wealth lost since 2008.

"I think it's five to seven years, maybe 10 years, before Ireland fully recovers. I don't think it's as long as the 25 years some people are saying.

"The underlying economy in Ireland is really strong, the funds industry is a powerful engine of growth, technology. I mean you've got real strength here that other countries in the eurozone don't have. I think you have to look and say the glass is half full."

He added: "I see hope in Ireland. I have been all over the world. The underlying earnings of Ireland are very strong. The funds industry, the financial services industry, the technology sector are very strong compared to other countries across the world. It's just this overhang from the property thing that is slowing things down."

Given his experience of the Lehman's crash, and his first hand knowledge of a major bank failing, I asked him his views on how the previous government dealt with our banking disaster.

"Transparency was the big problem in Ireland. There was a horrific lack of transparency of the actual holdings of Anglo. Investors were deceived; there will be prices to pay. In the US, we had the same problems, but here it was far more concentrated, far more dangerous, far more painful."

He added: "In Holland, the government took on the bad assets of the bank, and that got them out of it. Unfortunately, here, the size of the bite relative to the economy was really big, we are finding out after the fact."

About the same time I was meeting McDonald, down in the Four Courts another major development in Ireland's banking crisis was being played out, one which looks like a victory for the oft neglected taxpayer.

Investors in AIB subordinated bonds were locked in a court battle with Finance Minister Michael Noonan over his intention to burn their investments.

In a highly surprising 11th-hour move, Abadi Co, representing subordinated bondholders in AIB, withdrew the challenge to a court order secured last April by Noonan, as part of an effort to achieve some burden-sharing by bondholders in AIB.

The minister said Abadi's withdrawal vindicated his view that the challenge was unfounded and that the State was proceeding in "a legally robust and fair manner to deal with a crisis that should not be borne entirely by the Irish State and the Irish taxpayer".

AIB's liability management exercise offered to buy back subordinated debt for as little as 10 cent in the euro -- under a tender deadline of June 13 -- to raise up to €2bn towards the €13.3bn AIB must raise by the end of July.

In a further bonus for Noonan, Abadi said it has agreed to participate in the AIB debt buyback it had initially opposed. A separate challenge against the April court order by the Cayman Islands-registered Aurelius Capital Management is proceeding on Tuesday, but given the Abadi move, a similar outcome is now expected.

It also emerged on Friday last that Bank of Ireland has offered to buy back debt from subordinated bondholders for 10 per cent or 20 per cent of its original value in return for cash, or double this level if they accept shares instead.

However, despite the positive news on Friday from the courts and Bank of Ireland, it has not been a blemish-free week for Noonan. His department has confirmed that senior bondholders in Anglo Irish bank will now not be burned, as previously stated.

Given the news last week that Anglo Irish and Irish Nationwide would not need any additional state funding, following their own stress tests, Noonan's department has confirmed that bondholders will be paid up in full.

Financial Regulator Matthew Elderfield said losses may be imposed on senior bondholders at Anglo Irish and Irish Nationwide if the cost of the two failed institutions rises above the current €34bn bill.

"As a purely political matter, I'd guess that if and when Ireland gets a lower rate on its EU loans, that may prove to be the moment that they admit they had to give up on haircuts for Anglo bonds," UCD economist Karl Whelan has said.

Leo Varadkar's solo run last week aside, the bottom line is that even many within government circles believe that because of our banking catastrophes, our rampant public sector bill, and now our ever increasing debt mountain (now half of all income taxes raised), we cannot meet our financial obligations.

A year ago, a number of us in this newspaper and others began saying default was the only option, and we were vilified for saying so. Now, as McDonald says so, default is seen as inevitable. Let's get on with it and put this country on the road to recovery once and for all.

Sunday Independent

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