Both Donogh Diamond on last night’s Prime Time and Simon Carswell in this morning’s Irish Times provide useful overviews of the “Anglo options”. But there is a certain surrealness to the discussion. Behind the debate is what might be called an “extreme contagion” view of default on any bank liabilities. Investors have done a good job convincing the government that bad things will follow any imposed losses. This supposes some combination of backward-looking and grudge-holding market participants. It also seems to be based on the idea that Irish borrowers operate in narrow segments of the international debt markets, and investors there must not be annoyed under any circumstances. The media has taken the view that we can’t know what the consequences of loss imposition would be, so we should probably play it safe.
I do not think that independent analysts are that clueless. Patrick Honohan’s post on this blog back in May is worth re-reading. An extract:
It might be argued that losses incurred even by sub-debt holders of a bank could damage the credit of the Irish government. I disagree.
First, it is really immaterial that the bank is Government-owned: eveyone knows that situation has only arisen as a result of the disastrous performance of the bank. No new subordinated debt has been issued since the nationalization. Besides, in his statement in the Dail on January 20, during the debate on the nationalization bill, the Minister removed any doubt about whether nationalization entailed an expansion of the guarantee.
More generally, even though there might be an immediate knee-jerk reaction in market prices of debt, mature reflection by the financial markets would recognize that a country honouring its debts and guarantees to the letter–and not beyond–was more creditworthy than one which handed over money lightly to unguaranteed risk investors.
The government’s strategy seems to be to create a 100-percent credible implicit guarantee not to impose involuntary losses on any bondholders once the explicit guarantees expire. Obtaining future funding will be challenging. But a less costly approach for taxpayers would be a liberal use, if necessary, of prospective explicit guarantees. Attention should be focused on convincing investors that the Irish government will bear any burden to meet the explicit obligations—guarantees and sovereign debt—of the State. With all the talk of government reform, a good start might be to ban anyone from the Department of Finance from attending an “investor roadshow”.