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An Irish Chink in the Euro’s Armor?

Posted by Larry Doyle on March 29, 2011 6:03 AM |

In the midst of my recent travels around Ireland I was asked the following question by an Irish businessman. “Larry, when investors purchase senior bonds issued by banks, don’t they take risk?” I informed this friendly chap that based on how capitalism is supposed to work, that yes, these senior bondholders just like every other investor supposedly take risk when making an investment of this type.

My new friend then inquired as to how and why in Ireland’s recent negotiations with the EU’s hierarchy that the senior bondholders of Irish banks were not compelled to take a haircut. Knowing that we did not have enough time to fully pursue all of the angles to this topic, I gained an up close and personal appreciation for the disgust that many Irish citizens have for the recent ‘supposed support’ Ireland received by the EU and the European Central Bank. This situation in Ireland continues to play out as Bloomberg reported yesterday, Ireland Seeks to Force Losses on Bank’s Senior Bondholders,

Ireland said it wants to impose losses on banks’ senior bondholders, increasing the pressure on European policy makers to cut the costs of its bailout and provide longer-term financing for the country’s lenders.

The government, which took office last month, wants “a sustainable and comprehensive solution that involves recapitalization, but also an element of burden sharing as well as a funding package for Irish banks,” Agriculture Minister Simon Coveney told broadcaster RTE in an interview yesterday.

“A lot of delicate and difficult discussions are going to take place over next two to three weeks, if not slightly longer.” The government is raising the prospect of losses for senior bondholders to win a cut in the interest charges on its bailout and secure medium-term funding from the European Central Bank for its banks. European Union authorities opposed the imposition of losses on senior bondholders amid concern that could cause the debt crisis to spread to Spain and Portugal.

Could these bondholders be forced to take a haircut? What is the market telling us? The potential that bondholders will be forced to take a writedown (haircut) has recently driven rates on Irish debt to the moon. How high is that? Newser reported last week, Ireland’s Bond Yields Hit Euro-Era Highs on Fears of Eventual Default on Bank Bailout Costs,

The yield on Irish 3-year bonds topped 11 percent for the first time Wednesday and reached 11.13 percent Thursday. Trade in Irish 2-year notes has been more volatile, reaching a yield of 10.7 percent Wednesday but slipping back to 10.15 percent Thursday.

Ireland’s finances have been ravaged by the 2008 collapse of a property-driven boom and its decision to insure the banks’ foreign bondholders against losses. That bank insurance scheme, designed to prevent six Irish banks from falling like dominoes, failed to prevent Ireland from being forced to nationalize four of the banks and take a major stake in a fifth.

Those moves transformed the banks’ private bond obligations into a state debt burden currently estimated to exceed euro50 billion ($70 billion). More than half of the EU-IMF’s euro 67.5 billion ($95 billion) credit line has been earmarked for bolstering the banks. But Ireland says it will publish new stress-test results on four banks March 31 that could raise recapitalization needs by up to euro35 billion ($50 billion) more – unless a new deal shifting some losses to bondholders receives EU backing.

While concerns about Irish default are of immediate concern, there is an even greater concern lurking in the shadows. What might that be? My Irish friend informed me that he is beginning to hear sentiment within Ireland to screw the Euro completely and have the nation revert to using Irish pounds.

Time for a Guinness?

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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