Burning senior bondholders not necessarily bad

THROUGHOUT this “world’s cheapest bank bailout”, which has cost the Irish taxpayer mere dozens of billions to date, one policy of the Government has remained absolutely constant.

This is the policy that says that, under no circumstances, can the senior bondholders of Irish banks be burned, scorched, or even lightly toasted.

The phrase “burning the bondholders” has become code word for a policy whereby the senior bondholders, people who invested in the Irish banks in exchange for a return which, while low, was certainly and above that which they would have received had they lent to the Government, would be required to see their investment partially written off.

Remember that each euro in bank losses which is absorbed by risk capital, whether that be subordinated debt holders, equity, or senior bondholders, is one less euro the taxpayer will need to recapitalise the banks.

We have been told time and again, not just by government, but by those who have long experience in the banking and financial industry that to burn the senior bondholders would be tantamount to an act of gross irresponsibility, and would irretrievably and inevitably result in Ireland being “locked out of the international markets”, and would result in Ireland’s reputation being damaged.

Of course, like much conventional wisdom, this is total bunkum.

It’s quite clear that, in the negotiations surrounding the Irish bailout, the International Monetary Fund were quite willing to see a degree of mild scorching being applied to the Irish bank senior bondholders, but this was scotched by the European Central Bank.

The ECB are, of course, responsible not just for Ireland but for the entirety of the European financial system. And that is a financial system which relies very heavily on senior bondholders. Quite naturally, if there was to be a feeling that countries could burn senior bondholders this might well reduce the attractiveness of bank senior bonds as an investment, and would result in banks having to rely more heavily upon deposits.

It’s not at all clear to me that this would necessarily be a bad thing.

Yesterday, a press release from the European Commission read: “This press release seeks input from stakeholders, and all citizens of the community are stakeholders, as to the effectiveness of a variety of possible tools at a European-wide level in relation to dealing with failing banks.”

Chief amongst these tools will be . . . Burning senior bondholders. If a mere six weeks ago the Government had an opportunity to hang tough. Hanging tough would have meant using a threat — to unilaterally burn senior bondholders.

Let’s leave aside the fact that our “European partners” are charging us twice what it costs them to raise money on open markets. What is particularly galling is the fact that, very clearly, the commission had in its mind the need for a discussion across the community about burning senior bondholders.

It is to my mind inconceivable that any moderately competently briefed European government would not have been aware of this. And yet our negotiating team assured us that, not only was this not on the table, it could not have been put on the table.

We have been spectacularly ill-served by this government. Look at the negotiations around the bank bailout, from the very start in September 2008, it is clear that a poorly-briefed, ill-equipped government buckled under pressure from the banks. This continued to the very end in November 2010, when the same ill-briefed, ill-equipped crew buckled under pressure from the European Central Bank. The Government’s actions have been a litany of failure. They have placed the needs of the taxpayer at the very end of, rather than at the front of the queue, and all this has resulted in the very things which the Government claimed it wished to avoid.

We are now locked out of the international capital markets; we do not have a functioning banking system; we have lost our economic independence; we are dependent on the kindness of strangers, and they have proven themselves not to be particularly kind.

Six weeks ago the Government had an opportunity to force the pace in relation to what has now become at least potential European policy. If it just had the gumption or the willingness to do that it would have been not just in the Irish taxpayer’s interests but in the interests of all European taxpayers.

The next time a European banking crisis arises, the taxpayer will not be in the frontline. European taxpayers will have learned from the experience of the Irish taxpayer, experience which will have been dearly bought by us and cheaply learned by them.

* Brian Lucey is Associate Professor in Finance at Trinity College Dublin