I’ll take my turn linking to Colm McCarthy’s agenda-setting column in the Sunday Independent (available here).
While I don’t find much to disagree with in Colm’s piece, I worry that some readers might come away with the sense that default provides a relatively painless solution to our problems, which I don’t at all think is Colm’s view.
A few thoughts: First, it would of course be wonderful if a Europe-wide solution to the banking problem is pursued, one involving other countries absorbing a large chunk of our banking losses. It is unlikely to happen.
Second, some hold the view that defaulting on State-guaranteed bank debt (ELG) would be less costly than defaulting on State bonds. It would be good to see more discussion of why the reputational and balance sheet contagion costs would be less as a result of defaulting on State guarantees, especially given that available numbers indicate more than half of the bank bonds are held domestically.
Third, we have to recognise that part of the reason that the perceived default risk is so high is the perception that an orderly default will in fact be organised as per Colm’s advice. An orderly creditor “bail-in” – one supported by Europe and the IMF and probably involving additional funding – would indeed be less costly than the disorderly alternative. But making defaults less costly raises the expectation that a default will actually occur and thus raises the risk premium. We can see potentially self-fulfilling expectations of a default equilibrium emerging.
Fourth, we have to recognise that a more organised system of creditor bail-ins that makes it easier to restructure debt will itself make market access harder in the future.
Colm is right that the current bail-out mechanisms are deeply flawed and make exiting our creditworthiness crisis daunting to say the least. It would be a mistake, however, to conclude that there is some painless alternative that is not being taken because of stupidity or even politics. There are no easy solutions. We may end up going the default route. But given the costs of this route, the alternative of an assisted drive to shift expectations to the no-default equilibrium should not be too quickly set aside.