From a moral point of view, this would actually in some ways be more odious than subjecting government bondholders to a haircut or repudiating the bank guarantee in June in order to liquidate AIB.

And of course Morgan Kelly proposed neither course of action, but instead one - allowing the bank guarantee to lapse in September - that involves no government default at all.

These powers give the government substantial power to alter property rights.

Especially, it would seem, if they include the power to alter the standing of different groups of already-existing creditors. If the plan is to soak all the subordinated bonds in (say) AIB, and only the subordinated bonds, and it so happens that all AIB’s subordinated bonds have a long maturity, then maybe it’s possible to execute the plan without re-ordering the creditors (and without burning any creditors holding short-term debt). In any other case where the SRR shelters all short-term debt - especially, but not only, any case where some unsubordinated bonds are impaired but some subordinated bonds are not - this would seem (IANAL) to be an expropriation.

From a moral point of view, this would actually in some ways be more odious than subjecting government bondholders to a haircut or repudiating the bank guarantee in June in order to liquidate AIB. From the point of view of enlightened self-interest, the reordering would be to the immediate benefit of Irish government bondholders and (especially) the holders of short-term Irish bank debt, and it would signal to them the Government’s intention to keep them happy at present; however the reordering would also signal to them the Government’s willingness to break the rules when upholding those rules is no longer to its benefit. So a scheme involving an SRR that re-orders the creditors (as distinct from an SRR which does not) seems to defeat Prof. McHale’s intended objective of maintaining the reputation of the sovereign.

One way around this problem would be to have a straightforward insolvency or a special resolution process that doesn’t reorder the creditors, but for the Government to give the short-term bondholders compensation for their losses, in a like manner to deposit insurance. But that has several problems of its own.

Your mention of Econ 101 Principles rings a sour note. Not a single commentator has ever raised the issue of the totally daft economical (sic) ideas enclosed within the minds of these contributors. You cannot expect continuous exponential growth in a finite system - yet this is what they appear to believe in. If I’m wrong, please correct.

Growth: This is the Chief God - Easter Island type, you inderstand. Its like a creature emerging from a foggy, methane-ridden swamp. Until this is faced up to, no solutions can be found that will have any chance of dealing with the massive debt that the FIRE has given birth to - or should that be hatched from egg?

Most of the commentaries in this thread are interesting, in so far as they clarify some finance and banking issues about debt, solvency, bonds etc. But not a single commentator seems to have any grasp of the calamitous situation that is slowly emerging. They, (inc. myself) shall be forced to purchase our necessaries on a dimished income! Worse, energy costs and any oil-based manufactured good will slowly increment in price. (Its actually occurring but the effect is being masked by economic downturn). So the Great God of Growth will sink back into its swamp. What’s the replacement Rapanui then?

Would some of ye, please, try to explain to me what ye believe will ‘grow’ to such an extent that we will be able to emerge from this mess. Thanks.

Brian P

How much can banks make out of an economy that does not want to borrow? Debt spiral anyone?

To fix the deficit, we need taxes. Taxes are not always deflationary, discuss! By spending them, the masters of out universe will be combatting the deflationary effect of their cuts? Those who choose to pay taxes, would only have saved the money, sabotaging the consumer economy we all love.
This way the people that the voters most trust get to decide who gets their paws on it first! Reflationary or what?

Once we fix the deficit, we can then pay into the banks cos they were so good to us before, helping everyone to buy expensive housing.

Anglo and INBS I agree

The guarantee has not been zero cost Brian. Everything € we put into Anglo & INBS is an indirect result of having to prevent those banks from becoming insolvent and triggering the guarantee.

That is abundantly clear and sorry for the misinterpretation of your position.

But…I see this as an awful option for the taxpayer. It immediately precipitates the deposit guarantee, which so far has cost nothing and with a following wind never will cost anything.

Banking resolution simply allows a bank to be liquidated in an orderly manner. Ideally the bank would continue to operate 100% normally while assets would be sold in an orderly manner. Bondholders and depositors would get exactly the same proceeds from the sale of those assets.

The key point is that depositors would have a guarantee from the state for 100% of their money, bondholders would have nothing from the state.

This isn’t changing the rules the bondholders signed up to it is just giving extra protection to depositors and as I have always said the state is free to guarantee anyone or no one after liquidation.

Faced with such a dramatic shift in the ground rules the bondholders would accept a debt for equity swap. The point being that the threat of liquidation then becomes very real and not the kamakazi bluff which it is under current rules, thus severely weakening the bondholders’ negotiating position.

Okay, that sounds logical. Problem is the official line is that AIB/BOI are solvent, merely short of a capital cushion, so no immediate scope to torch bondholders or force them into a debt equity swap.

I suppose the bondholders couldn’t complain if any extra state capital in some way ranked above them at any future liquidation. It would be a funny instrument, equity as a going concern but ahead of bondholders on a winding up.

They aren’t entitled to have a defacto veto over reform of bankruptcy laws within the state.

To allow the banks liquidate under existing rules would be seen, as you say, as a private company default and not an act of national default, I agree.

But not even Kelly is asking for that. What seems to be being suggested is that the government should change the rules of the game retrospectively so that bondholders are placed in a much weaker position than under existing legislation and so that they will be forced un their knees into negotiating a debt equity swap. That to me is a national default or national breach of faith. The suggestion that we could just shrug our shoulders and say that’s a private company matter when we had changed the law to facilitate a certan outcome is disingenuous in the extreme.

A bank resolution regime simply allows greater controls the liquidation process and allows the bank to continue to operate as normal during that process under control of the state or regulator.
I see nothing that changes the legal claim the senior bondholders have over the assets of the bank.

I am sorry but the liquidation of the banks is not the same as national default. It is the default of a private company. And it we wait until Kelly’s prediction is becoming likely then it will be far too late. Better to cut the banks lose now IMO.

Absolutely nothing was to be gained by leaving some bonds out of the guarantee. People forget the guarantee was only for TWO years. To argue that we should have left out some bonds is to argue that by now we could have defaulted on these but that would mean liquidation, exactly what we are trying to avoid. the two years are almost up and we need to make a call again. Maybe someday liquidation of the banks will be the least worse scenario. If Kelly’s armageddon looks like unfolding we will have plenty of time to swallow the poison pill of natonal default - far too early for that yet.

“Surely this bank resolution thing requires legislation and cannot be retrospective. Senior bondholders got +20bp for their “risks”. If there was any prospect that they could be discriminated against v depositors they would have needed 400bp at least. They were providers of funds not capital.”

Eoin keeps repeating this line of defense as well and I think it is complete rubbish.

Firstly, the notion that ANY investment should be risk free is completely bogus. Capital isn’t risk free and neither is funding!

Secondly, one of the major causes of the current crisis was the mis-pricing of risk. Risk was under priced everywhere including Irish bank senior bonds.
Before the crisis Greek bonds was 25bps over German bonds. Would you consider these risk free now?

I think saying that senior bondholders only demanded 20bps over therefore they assumed the bonds were risk free therefore they should be bailed out is a circular argument.
The fact is that investors in corporate credit all over the world under priced the risk. Should they all be bailed out because they assumed that they were taking on far less risk than they thought?
How much was demanded for B rated bonds, how much was demanded for junk bonds? How much is demanded now?

The investors got it wrong in demanding only 20bps but I can’t see how their fundamental mistakes should be paid for by the state.

From your link

‘Mr Daly (NAMA) said that due diligence by his staff had discovered remarkable flaws in the legal agreements that developers had signed to secure their loans. He said that “much of this lending was carried out in haste and inadequately secured and documented”, making it difficult to pursue developers for the personal guarantees that many had offered to secure their loans’

Goodness me. Must have been the champagne.

Surely this bank resolution thing requires legislation and cannot be retrospective. Senior bondholders got +20bp for their “risks”. If there was any prospect that they could be discriminated against v depositors they would have needed 400bp at least. They were providers of funds not capital.

However, all this is rapidly becoming a petty little side-show and the finite resources that may be deployed at the EU level to help get the silly Paddies out of the mire now have a much more serious call on their attention. The entire EU project is at risk.

The hard-headed scepticism of bond investors is being pitched against the nebulous EU ideals of competiiton, co-operation and solidarity. These might have some substance if the EU elite had made an effort to bring thier voters with them, but, for the last 20 years, the project has been pursued by the Council and Commission in a way that by-passed national parliaments. The European Parliament has proved an inadequate substitute.

The chickens are now coming home to roost and it would be a brave person who would pronounce confidently on the outcome.

An indictment of those involved in the mess! No surprize but Cow and Lie, aptly named and Eoin, both anonymous boosters of BS, may seek to address the isses raised?

So at 440 bn in assets, 12% would be about 50 bn in losses. The banks need to be left capitalised at the end of all this, so we can’t actually count existing equity (it will have to be made up). As the banks had almost no loss reserves coming into the crisis, all losses will require recapitalisation in the absence of resolution. No?

Lake Woebegone, eat your heart out!

‘The government having discovered (or created!) the errant cousin whose huge gambling debts have caused a crisis have responded by printing IOUs and for the first time in a generation bringing the very solvency of the state into question’

Exactly. Nothing could more clearly illustrate the fact that our history is so very different from our European neighbours. They are centre and we are periphery. The local Powers that Be have chosen to protect the assets of their various clans clan by sacrificing our state. Sleepwalking.

The fundamental solvency condition boils down to asking if no default / no risk premium (i.e. no expectation of default) is an equilbirum. Of course, this could be an equilibrium and default / high risk premium (i.e. high expectation of default) is an equilibrium as well. The high interest rate is what eventually forces the default. The bottom line is that fundamental solvency is not enough. One the policy challenges is then to prevent markets co-ordinating on the bad — i.e. default — equilibrium. In the current volatile markets, it is not hard to imagine a shift to a bad equilibrium coming about. That is why policy measures such as the international stabilisation fund at the country level and the ability to guarantee bank debt at the national level are so important.

While I can see that my piece today is likely to be read as being more sanguine about the getting into funding difficulties than Morgan’s, I hope it comes through that I am very concerned about a bad equilibrium taking hold. That is why I put so much emphasis the importance of protecting the credibiliy of state promises.

We also have a very short window of opportunity to negotiate with the bondholders and the current administration has made it very clear that they are going to give the bondholders as much government paper as they can print to meet all “liabilities” making future default inevitable. Witness EBS.

The government having discovered (or created!) the errant cousin whose huge gambling debts have caused a crisis have responded by printing IOUs and for the first time in a generation bringing the very solvency of the state into question.

I take your points about solvency depending on capital injections/guarantees. As a practical matter, however, once given, I don’t see how decisions about bankruptcy (or alternative resolution mechanisms) could be made as if these interventions had not taken place. Don’t governments need to protect their ability to make credibe promises?