Last night’s The Week in Politics on RTE featured an important discussion between the Minister for Finance, Brian Lenihan, and Fine Gael finance spokesman, Richard Bruton (The discussion is in the first clip on the webpage after Brian Dowling’s report). They discussed a number of issues such as NAMA and Anglo Irish Bank. However, to my mind, the most important discussion related to bank bond holders.
Fine Gael have proposed that the government should announce that the wholesale guarantee on bank liabilities will not be renewed beyond September 2010. Their plan would most likely see unguaranteed subordinated debt-holders being wiped out at that point and other bond-holders being repaid in order of seniority. (More likely, an announcement of this sort would “telescope” this process so that the banks could immediately negotiate with exposed bond-holders about paying cents on the dollar for the debt or converting some of the debt to equity, rather than waiting sixteen months.)
The Minister for Finance strongly disagrees with the Fine Gael proposal. On The Week in Politics (about 8 minutes in) he said the following:
Richard casually mentioned there the idea that investors should take some of the sacrifices as well. I went around Europe and raised a lot of money for Ireland in the last few weeks, and investors would be horrified to know that the main opposition party in this country wants us to default on payments to them in Autumn 2010.
Bruton replied that these investors were bank investors, not state investors. At this point the Minister made the following points:
These professional investors are the same international investors who invest in our government bonds … We need a lot of government bonds this year … If the idea is out there that Ireland, or its banks, are going to default on international investors, we as a country will not be able to fund ourselves … There is a direct link between the senior debt which is raised by the government and the senior debt that’s raised by the banks. If you start defaulting on one, inevitably it becomes harder to raise the other and your interest rates will go up and up and up.
Bruton responded that one of the reasons sovereign interest rates were so high was the concern that the state would have to pay off all of the bank bonds, so that sovereign interest rates could fall if the bank bonds were not fully paid out on.
The Minister has followed up on his comments on this important issue today. On Newstalk this afternoon he referred to FG’s plan for bondholders to lose out as “nonsense policy” and dismissed the idea as something thought up by “theoretical economists”.
Now I’m not a theoretical economist but I guess I’m about to be damned with this accusation because my inclination is to side with Deputy Bruton on this one. Bonds issued by Irish banks are not the same thing as bonds issued by the Irish government. A default by an Irish bank does not in any way have to imply that the Irish state will also default on its debt. Ultimately, sovereign default risk will depend on the fiscal solvency of the state and this will be improved by implementing a solution to the banking crisis that minimises the cost to the taxpayer.
I guess that the most likely response to these points is going to be along the animal spirits lines—yes it doesn’t really make sense for Irish bank debt and Irish government debt to be seen as the same thing but sure that’s the way these funny international investors carry on. I’m more inclined to reckon that international investors worry about the bottom line and so attempt to focus rationally on the factors that affect sovereign default risk. But perhaps that’s just my inner theorist winning out ….