There have been some comments on this blog this morning on the popular subject of bank bonds.
Let me point out some facts and then some questions for debate.
The facts: On Monday, January 31st, Anglo Irish Bank are going to pay out on a maturing bond worth €750 million. (For reference, the total cut in this year’s welfare budget will be €873 million.) The investors who purchased this bond invested their money with Anglo on the 17th of January 2006. The bond is senior unsecured debt and is not covered by a state guarantee.
The questions: Should the government have passed legislation this month to allow the Minister for Finance to intervene so that the bank did not pay this bond back? And if so, should the next government pass such a bill in relation to the remaining €4 billion or so in outstanding unguaranteed bonds owed by Anglo and INBS?
In answering the question, it’s worth noting that the logic of the section of the recent Credit Institutions (Stabilisation) Bill relating to subordinated debt suggests that a government can change the terms and conditions of bonds to apply haircuts if the bank owes its continued existence to significant amounts of public money being injected.
It is unclear whether this power can simply be extended to senior bonds but it seems to me that it can. Another issue is whether such changes in terms and conditions can legally work to allow a bank to distinguish between different types of unsecured creditors that start out with equal claims, by haircutting bond holders but not deposits. Mechanically, of course, one could achieve the same outcome by haircutting both senior bonds and depositors and then compensating depositors via a separate piece of legislation, but this would be more complicated.
The other issue is the implications of a default on a senior bond for the Irish and European banking sectors. My belief is that how this plays depends on what investors believe is the precedent being set. If the precedent is that investors can lose out if they place their money with banks with flawed business models, who engaged in shady business practices and then become grossly insolvent—then surely this is a precedent that must form part of new proposals for dealing with failed institutions?
On the other hand, one could argue that at such a sensitive time for the Irish banking sector, defaults of this type would send the wrong message and worsen an already extremely serious liquidity problem. This is the argument put forward by our new best friend, Mr. Bini-Smaghi.
I’m open to considering all sides of this argument. On balance, however, I’m inclined to the position that it is in the interests of both Irish citizens and those in the wider EU to set a precedent with the Anglo and INBS bonds that there need to be limits on how much support European taxpayers will provide to insolvent banks.