Dan O’Brien on Burning Bondholders
This post was written by Karl Whelan
Dan argues the ECB case for not burning Anglo bondholders in today’s Irish Times. I’ll quote the main argument at length
Apart from Ireland, nobody else in the euro zone has sought to make seniors take their losses so there are no cases to which one can point as evidence. But an immediate neighbour’s experience has been watched very closely. Denmark last year introduced the toughest bank resolution laws in Europe. These laws, which govern the winding-down of bust banks, are more similar to those in the United States than those across the rest of Europe. In the US, senior bank bondholders have traditionally got their just desserts if the institutions they invest in fail.
When two Danish banks failed earlier this year, their seniors were burned. This raised funding costs for the entire Danish banking system.
From the euro zone perspective, the ECB is obliged to consider that if a default precedent were to be set in the senior bond market, then at the very least funding costs for all banks in the zone would rise. The savings for Ireland of a few billion euro would be offset many times over by the generalised increase in funding costs for the already-teetering euro zone banking system.
That there is good reason – in the collective European interest – not to burn seniors does not lessen the injustice of having Irish citizens pay for European bankers’ losses (although the hugely subsidised bailout loan is a partial de facto spreading of the burden).
The point that burning senior bondholders may raise the cost of funding for banks is a fair one. But the relatively lower cost of bank funding obtained from a policy of supporting all senior bondholders is hardly a free lunch. The additional risk that the market would perceive as being attached to bank bondholders would have been transferred away from sovereigns.
Now one could argue that some sovereigns in the Euro area are in a position to take on this kind of risk in order to protect their banking systems. But others clearly are not.
My position on this is that there is no need for the question of burning senior bondholders to be a simple black or white proposition. As I discussed in this paper, the EU could adopt a policy that sees senior bondholders only incur haircuts if equity and subordinated bonds have been wiped out, the bank has been nationalised, and the state has incurred costs of x% of GDP to bring the bank back to solvency.
What x is could be a matter for policy discussions, and could evolve over time. But a policy that set x=5% would mean that the EU is only ruling out bailouts that would place enormous burdens on the state. Indeed, given the state of Euro area public finances, there simply isn’t room for another round of expensive bank bailouts so an approach of this sort may help to reduce the perceived riskiness of much of Europe’s sovereign debt.
This policy could see the remaining Anglo senior bondholders receive severe haircuts without implying a contagion effect for other institutions apart from those the market suspect to be severely insolvent and to which states should probably be reluctant to offer blanket liability guarantees.
But, of course, such a policy would tradeoff state and private sector interests in a balanced way and, as I argue in this paper, M. Trichet’s approach to the question of debt defaults has consistently been characterised by dogma rather than balance.
Tags: Anglo Irish Bank