Monday 18 February 2019

To default or not to default: that is the burning question

Do we cut our losses and burn unsecured bondholders -- or do we sacrifice ourselves for Europe, asks Daniel McConnell

Daniel McConnell

CALLS for Ireland to default on at least a portion of its debt have intensified in recent weeks, culminating with the matter being discussed this weekend with the fine chaps from the IMF and the EU.

A growing consensus -- both at home and across the world now -- is of the opinion that Ireland cannot support the huge debt burden it has taken on, mainly because of the recklessness of negligent and greedy bankers.

Ergo, at least some of that debt must be reneged upon.

Since September, with the lapsing of the original bank guarantee, subordinated bondholders (or high-risk lenders) have been cast off.

Much of the crisis in the markets engulfing Ireland was sparked by Angela Merkel's correct but woefully timed suggestion that senior bondholders must also share some of the burden.

As an illustration of how jittery people are, Friday's story in The Irish Times that default was being discussed at the meetings with the IMF was enough to cause investors to flee throughout the day, causing carnage on the markets.

There are very strong reasons why default should be considered. As we know, the strongest argument against it, from Ireland's perspective, evaporated last week -- that argument was that any default on bank bonds would cause lenders to stop making money available to the Government at an affordable rate.

That has already happened and if we successfully conclude our negotiations with the EU and the IMF, we will have no need of the bond market for the foreseeable future.

I have long been of the view that those who took a punt on investments and lost should suffer the consequences of their own poor judgement.

Those in favour of defaulting say it is the least painful and most effective means to avoid becoming the first country in Europe to undergo a dysfunctional collapse.

Some proponents claim that €180bn worth of the banks' debts can be written off via a debt-for-equity swap. Discount this amount by the funds that the new equity holders in the banks will have to put into capital, and the figure falls to somewhere closer to €150bn.

Restructuring bank debts will stop the horror of contagion from the sick banking sector and recklessly spending Exchequer to the healthy sectors of Irish economy.

They say the current adverse news flow surrounding the banks and sovereign finances is leading to a collapse in trade, and putting pressure on our exporters. The bailout also rewards bondholders over ordinary people who had no part in the crisis.

The Irish will have to suffer through falling wages and a rapidly contracting economy as the country struggles to pay its debts.

This is purely a political choice and the wrong one -- the Irish Government should serve its people, not bankers.

By rewarding bondholders and paying them back for their stupid mistakes, we create a moral hazard.

They should be punished for their failure. Bailing them out means they'll continue to take risks with the assumption they'll be bailed out again. The same goes for people who've been lending money to these banks.

As has been pointed out, both Russia (1998) and Argentina (2002) defaulted, restructured their debt, and came out fighting.

However, given the current threat to the frail euro many are deeply fearful what impact a default would have not just on Ireland but on the entire eurozone. There is a view that the system couldn't survive the direct and indirect effects of a default shock -- the direct effect would be tens of billions of losses distributed across the system and the indirect effect would be panic as other bondholders realised that their government-backed protection had been removed.

Ireland and its banks have been surviving on short-term emergency loans from the ECB since September 2008. It was the ECB that pulled the trigger and forced Ireland to request a bailout because it is concerned over how much it has lent to our banks.

The figure jumped from over €60bn four months ago, to over €130bn now.

Up to now, the Irish Government has repeatedly insisted that defaulting on senior bondholders is not an option. "The position is that under Irish law, senior debt obligations rank equally with deposits and other creditors," Finance Minister Brian Lenihan said last month. "I have no plans to change this position.

"There is, therefore, no question of seeking to impose losses on holders of such debt in Anglo Irish Bank or, indeed, in any credit institution in the State through any legislative measures."

Those opposed to default say it would do untold damage to Ireland's reputation and to our ability to fend for ourselves. Such arguments have been negated in the past 10 days.

The application of a 50 per cent haircut to such loans could impose a loss of €5bn on Irish pension funds, insurance companies and even the banks themselves.

The second objection to burning the unsecured bondholders is that it has the potential to destabilise the international bond markets by creating contagion effects. As stated above, we are already seeing signs of contagion in Iberia because of the news that default is being considered.

Those against also say a partial default by Ireland on its banks' senior unsecured bonds would send a strong message to the international financial markets that governments and banks had become even more untrustworthy. Ultimately, if Ireland does default, surely it will be better if it happens after we have received the bailout money and the system has been reformed and restructured so that it can absorb the losses without the risk of meltdown. Many of the perceived negatives of considering default have or are already happening to Ireland.

We must not allow ourselves to be bullied around even it is not the best option for Europe. If it is the best option for Ireland, then that is the course we must follow.

Sunday Independent

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