Making bondholders pay ‘would cause contagion’

SHOULD Ireland decide to make senior bondholders pay part of the cost of restructuring the banks, it would cause market contagion, a senior economist has warned.

Willem Buiter, Citigroup chief economist, said he believed that it would be better if the eurozone agreed on such a step together, but he thought this was unlikely.

“The real question is will Ireland go it alone, which would upset its European partners and cause market contagion throughout the EU,” he said.

The London-based analyst said he agreed with Alan Dukes, chairman of Anglo Irish Bank, who said earlier this week that he believed the cost of cleaning up the country’s banking system will be around €100 billion.

He predicted that the EU leaders at their summit towards the end of March will not agree a flexible and comprehensive package that would reassure the markets. “After March they will all be back in crisis mode. Beware the ides of March”, he said.

State support for unhealthy financial institutions should be removed as soon as possible, and he believed that by the end of the year banks could be either restored to health or eliminated.

“While Ireland is still being beaten up for wanting to haircut senior unsecured creditors, we will soon be in a situation, even by the end of this year, where we can do this Europe wide and European banks can be restored to health or put out of business by making senior bondholders pay rather than taxpayers,” he told the European Financial Services Conference in Brussels.

Fine Gael has committed to forcing certain classes of bond-holders to share in the cost of recapitalising the banks, initially for junior bondholders but also for senior debt for Anglo Irish and Irish Nationwide that are being wound up.

A report drawn up by European Commission staff, some of whom were involved in drawing up Ireland’s austerity plan, said that following the initial planned recapitalisation of €10bn, additional recapitalisation needs could arise as a result of loan losses.

This could be met from the further €25bn available under the programme – partly from the EU-IMF loan and partly from the €17.5bn from Irish sources, mainly the pension fund.

The report warned that such losses could be driven by the deleveraging process which is expected to begin after the stress tests are completed next month.

It also stresses that were the macroeconomic situation to worsen significantly beyond the scenarios set in the stress tests, further pressures on banks’ asset quality and solvency could call for additional capital injections. This could be mitigated by external sources of capital for Bank of Ireland and liability management exercises recently launched by AIB and BOI.

The Commission refused to comment on the scenario described by Mr Dukes in which he said the €35bn envisaged for capital injections would not be sufficient and would need to be increased by €15bn while an additional €50bn would be needed to create a clean banking sector.