Bank bondholders escape again as a protected species of capitalism

 

BUSINESS OPINION:The hammer of moral hazard will eventually come down but it may be too late for Ireland, writes JOHN McMANUS

FOR A brief moment on Friday, it looked as though for the first time in Europe’s handling of the financial crisis the holders of senior bank bonds were going to join the rest of us in the world of moral hazard.

But it now seems that the issue of the senior bond holders in the Irish banks being asked to participate in the fourth bailout of these institutions was effectively shelved on Saturday.

It followed a tumultuous day on Friday during when investors took fright over reports that the rules of capitalism might be interpreted in a way which did not favour them. The Irish banks had their credit ratings cut even further and the price of their senior bonds fell. Market participants queued up to predict Armageddon and worse.

As usual, Armageddon did not arrive but it was a big enough fuss apparently to allow the European Central Bank (ECB) win the day during the intensive discussions on Saturday with the International Monetary Fund (IMF) and the European Commission. The decision of various derivative counterparts of Anglo Irish Bank to start withdrawing credit lines was probably the decisive factor.

It was not a Lehman moment – the global financial system has moved on from there – but it was as close to contagion as the ECB and the others members of the troika wanted to come.

Once again the least risky option has been taken by the European authorities in handling the crisis. Once again an evil day has been put off ,and once again Irish taxpayers shoulder a bigger burden than they deserve. The path of least resistance is followed.

The various decisions made by the Government in its handling of the crisis – starting with the blanket guarantee in September 2008 – have been made in lock step with the European authorities. On every occasion, the preferred course of action has been to apply first aid rather than carry out the major surgery that is ultimately going to have to take place.

One suspects we will hear a lot in the coming weeks justifying pragmatism winning the day once again.

We will be told how making senior bond holders face up to the consequences of their bad decision would have had all sort of unpleasant consequences. The most pressing – from the ECB’s point of view – is the possible pariah status of what is left of Ireland’s banks making it impossible for them to wean themselves off ECB funding.

The other argument we can expect to hear repeated is the one most recently voiced by Deutsche Bank chief executive Josef Ackermann to the effect that while such things are right in principle, the truth is everybody gets hurt when senior bondholders get hurt because the bonds are held by life insurers and pension funds.

Ackermann is right, of course, but, as he undoubtedly also knows, these long-term investors only benefit from markets that are functional and where losses fall where losses should, and this includes senior bank bondholders, not withstanding a guarantee by the Irish Government.

He must also know – as must the ECB – that ultimately the markets find you out.

The speed with which even the mere suggestion of burden sharing with Irish bank senior bond holders sent the market into paroxysms indicates that they know the day of reckoning is coming.

But, it would appear that once again the reckoning has been postponed and Europe limps on with over-borrowed peripheral states being spatchcocked to preserve a fiction that Europe’s banks do not have to confront billions in losses as a result of lending to these countries.

One way of looking at the events of last Friday was that the IMF – taking a more global view – pushed to try and face up to the issue in a limited fashion by introducing some very limited form of burden sharing in the Irish package.

The idea was duly floated, the markets kicked up and it was quickly shelved. What will become clearer in the coming weeks is whether the cat is out of the bag.

The authorities may have blinked first, but a process may have been set in train that will see the abandonment of the position that senior bond holders in European banks are a protected species.

The fear is that this does not come in time to make any difference to Ireland as we plough on with our commitment to senior bond holders intact and end up being the only fools to pay them out.

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