"Burn the bondholders!" has been the blood-curdling cry from the Irish man in the street ever since the devastating scale of Ireland's bank bailout became clear. Now it's time to get out the matches.
In October, Finance Minister Brian Lenihan said that junior bondholders in Anglo Irish Bank would be expected to make a "significant contribution to meeting the costs of Anglo." That has now been revealed to be an 80 percent loss for junior bondholders. But why should they get even 20 percent back on their catastrophic investment?
If you bet on the wrong horse at the Kentucky Derby, would you get 20 percent back? They decided to invest in Irish banks in order to get higher returns over a safer investment. They bet on the wrong horse.
However, even this paltry haircut only applies to junior (or subordinated) bondholders. Mr. Lenihan last October indicated that the state was wary of scaring markets by defaulting on Anglo's senior debt: "We have to get bondholders from overseas to fund the Irish state, and to fund the substantial deficit," he said. "You can't go to your bank manager and say, 'I want to default,' and at the same time, 'I want more loans.' If that's the underlying message coming out of Ireland, we're not going to flourish as a country."
Back then, senior bondholders were a sacred cow: "If we burned them, then who would lend us money? We would be forced to go to the IMF" the argument went. Well, now that we are in the IMF, we can take a flamethrower to the bondholders to our hearts' content, as we wont be looking for money from the markets for years to come.
Despite knowledge of an impeding IMF bailout, Mr Cowen last week noted that bondholders and depositors rank parri passu (equally) under Irish law. This was an attempt to dampen further calls for bondholder incineration by implying that, if we burn the bondholders, then you and your granny will also lose your savings.
One thing Cowen doesn't get is that the government, by its nature, can change laws. They could, tomorrow morning, change the law so as to rank depositors ahead of senior bondholders. In this way, as banks get wound down, ordinary individual depositors are protected and the (mostly foreign and institutional) bondholders get fleeced. There is also an argument that the government's bank guarantee is invalidated due to the likelihood that the guarantee was predicated on misleading information given by at least some banks.
Economist David McWilliams also says that we should burn the bondholders and that the markets would respect us for doing so. He suggests doing so by way of a debt for equity swap, which would mean forcing senior bondholders to take nearly worthless shares in the banks, which might increase somewhat over time, junior bondholders will have to take a hit.
Even the ever level-headed Dan O'Brien, economics editor of The Irish Times, says this morning: "Many serious people, in Ireland and elsewhere, have reached the conclusion that the Irish State cannot support the debt burden it has taken on.
"Flowing from this conclusion comes the view that a portion of that debt must be defaulted on. The most obvious and frequently mentioned portion of that debt that advocates of default point to are monies lent to Irish banks, including senior bonds.
"There are very powerful arguments to support the default view, and the strongest argument against it, from Ireland's perspective, evaporated last week ... It is no longer in Ireland's narrow national interest to prevent senior bondholders from suffering the consequences of their own bad judgment."
However, O'Brien advocates waiting until the financial system has stabilized so such defaults can be arranged in an orderly fashion.
Happy days, though: it looks like the gut instinct of the Irish people was right all along. Indeed, many argue that if we burn the bondholders now, when we go back to the markets in a few years' time, bondholders will actually be more likely to lend to us and reasonable rates as we will have less of an overall debt burden.
The New York Times, in an editorial published yesterday, also argues that senior bondholders must be hit hard:
"Debt write-offs weren't discussed during the Greek bailout, not least because it owed a lot of money to banks from other European Union countries. Ireland owes even more. Right now, nobody is talking about restructuring. Instead, the European Union and the I.M.F. seem likely to plow billions more into the Irish banks.
"Forcing creditors to swallow debt write-downs also carries big risks. It would hurt the balance sheets of many European banks. It would spook investors... [but] Creditors in Ireland's banks could be pressed to swap debt for equity, which would reduce banks' indebtedness. And the I.M.F. and European Union rescue fund could inject capital into some banks that couldn't get it from the markets, as well as shore up governments until they recovered access to private financing.
"This won't be easy, especially if the rescue needs to be extended to a much bigger country such as Spain. Yet despite the risks, this approach may offer the only path to lasting solvency for these countries -- and long-term stability for the euro."
The only people who benefit from our not burning the senior bondholders are the states, banks and big investors who are owed money by our banks. The Irish people however, have no interest in paying to rescue these bondholders for decades to come.
The EU has a vested interest in loaning us money for future generations of Irish people to repay to support to their banks, who in many instances are the bondholders, and to stabilize the euro. Any EU money will likely be conditional on Ireland agreeing to repay a significant sums to the bondholders. The government must see through this ruse and borrow from the IMF only, if needs be.
However, it looks like even the EU now sees that the senior bondholders must make some contribution. The Irish Times this morning reported that a "source said there was a 'common understanding' between delegations from the EU, the ECB and the IMF that senior and junior bondholders should each pay a share of the rescue costs. The first step would be to seek to 'persuade' senior bondholders to participate in the bailout, said the source. 'If that doesn't succeed, the question is how can you force them in a legally-sound way.'"
The time for such legal niceties is over. Here's a top investment tip for the next Irish government: buy matches and petrol. Burning the bondholders and defaulting on bank debt, if not also sovereign debt, now makes complete sense for Ireland.
As Homer Simpson once said: "Default? Woo hoo! The two sweetest words in the English language: De- fault! De-fault!"
UPDATE: Thanks for all the very insightful comments. Just to clarify on the proposed bond default: These were not actually government bonds but bank bonds that came under the terms of a 2 year guarantee issued in a panic during the September 2008 global crisis. It expired last September but was extended for 3 months. It can be left lapse at that point and the bondholders left take the hit.
As Paul Krugman noted in the NY Times yesterday:
"the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody's fault but their own. But, no, the Irish government stepped in to guarantee the banks' debt, turning private losses into public obligations."
This is why Ireland should leave the bank bondholders suffer. It was a reckless and ill-informed government that put our nation, for generations, on the hook for bank and investor liabilities:
Here's David Mcwilliams, one of Ireland's leading economists, explaining more on the issue:
"Taking account of sovereign bond redemptions and deficits, Ireland needs about €74bn over the next four years. The banks are getting €90bn of funding from the ECB and another €35bn from the Irish Central Bank. So, to get everyone off the hook, €199bn is needed. We can add that number to the national debt (net of redemptions by 2014 and cash balances) of €76bn and come up with a total of €275bn. Or just over 200pc of GNP.
There is no hope of Ireland ever being able to repay this amount. Nominally, if there is a large growth of inflation in the European and Irish economy, it might be possible, but with tight monetary control from Frankfurt, that is not going to happen.
So we need burden sharing with bank bondholders to reduce the liability the State has encumbered itself with through the mishandling of the bank guarantee. The alternative being presented by the run on Spain is that sovereign default is not only more likely, but should be viewed as being in Ireland's best interest. Loading up on IMF and EU debt right now -- in order to bail out the banks -- only makes sense for us if we have no intention of paying the money back."
For more see NewsWhip.ie's "Burn The Bondholders Friday"