Debt crisis - Paying all creditors will not work

The stress tests were only about the amount of money ultimately needed to facilitate the bank bailout, but the next issue is where to get the money.

During the election campaign both Fine Gael and Labour indicated they would try to ensure that senior bondholders would share in the burden of the banking loses.

Mohamed El-Erian, chief executive of PIMCO, which manages the world biggest bond fund with investments worth more than $1.2 trillion, warned in an interview with Bloomberg TV on Thursday that the strategy of paying back all one’s creditors in a debt crisis has not worked throughout history and will not work in Ireland’s case. He added that while the International Monetary Fund and the European Union were doing their part, Irish taxpayers were “doing more than their fair share”.

“Most of the creditors so far have not gone through any burden sharing,” he said. The Government’s decision this week was essentially a political decision. “It surprised me,” he added. “I don’t think you can sustain that political decision.”

In fairness Fine Gael did stress during the campaign that it would strive to secure full burden sharing, but it would only press the issue with the agreement of the European Central Bank in Frankfurt. “But we didn’t get the agreement,” Finance Minister Michael Noonan admitted yesterday.

However, the ECB has agreed that subordinate debt is not untouchable, so the subordinate bondholders are being compelled to contribute. If additional capital is required for Anglo Irish Bank and Irish Nationwide, the minister said, the whole issue of the senior bondholders would have to be reconsidered. Those two banks were not part of the stress test, as they are already being wound down.

Restructuring of Bank of Ireland and AIB requires that they should be on solid basis, and Mr Noonan warned that their capacity to get funding would be seriously impaired if their senior bondholders were burned. Thus, instead of confronting Frankfurt in relation to burden sharing, the Government conceded to the demands of the ECB, which, in turn, has agreed to continue to lend Irish banks up to €200 billion on an on-going basis.

People will no doubt remember that Mr Noonan was a member of the Government that came to the rescue of AIB during the Insurance Corporation of Ireland crisis in 1984. AIB then turned around and treated the Government and taxpayer with contempt. AIB does not deserve the current help but this is not the time to settle old scores.

By co-operating with the ECB, the Government clearly hopes international creditors will come back into Ireland with new money, but El-Erian warns that the Government has not read the history of debt crises. Because that history has repeatedly shown that no new creditors will invest in a big way where there is a serious financial debt cloud. In short, he believes members of the Government are deluding themselves.