FINALLY! - Ireland Issues Threat To Billionaire Bondholders

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• Slideshow - Ireland Rages Against The IMF

This is the heart of the bailout battle. Taxpayers vs. bank bondholders. In Ireland, the debate is front page news. On Friday, the leading opposition party, Fine Gael (pronounced feena gail), put forth a multi-point plan to deal with Ireland's banking and sovereign debt crisis. This weekend we made note of their plans to secure a $50B loan from the Federal Reserve, but perhaps more significant is their open threat to bank bondholders:

• "Fine Gael ... is committed to forcing certain classes of bond-holders to share in the cost of recapitalising troubled financial institutions. This can be done unilaterally for the most junior bondholders (owners of preference shares, sub-ordinated debt and similar instruments), but should be extended - ideally as part of a European-wide framework - for senior debt for institutions like Anglo Irish and Irish Nationwide that no longer have any systemic economic importance."

In other words, banks will be allowed (forced) to default on debts they owe to some of their creditors, including Goldman Sachs. In the post-bailout world, and outside of Iceland, this simply is not done. Even though, as we pointed out months ago, it's going to happen eventually anyway.

In December, we wrote...

If it isn’t clear yet, Ireland will default on its bank guarantee. The IMF bailout of French, German and British banks is more than the Irish economy can afford, and far more than the Irish people are willing to allow....

Again, the only option -- the only viable option I should say (even if the Cowen’s and Lenihan’s of the world are too thick to see it) -- is to default. We’re not talking, of course, about defaulting on Irish government bonds, but defaulting on the ill-advised bank guarantees that went into place in the fall of 2008.

At the largest banks (Allied Irish Banks, Bank of Ireland, et al.) the plan appears to only threaten junior creditors. But at the notorious Anglo-Irish Bank, they are threatening to whack ALL bondholders (as they should).

Now, Fine Gael is being very careful how they word their ostensible plan. Notice that they include a reference to the debt restructuring occurring in the context of "a European-wide framework." That is because the terms of the EU bailouts of the Irish banks preclude any kind of bondholder haircuts without European approval. If that's the case -- that the EU and the ECB will still have a veto over any moves by the Irish government -- then this is just mamby pamby stuff meant to fool Irish voters. It will never happen.

However, Fine Gael also says:

• "Should some credible combination of these (above) options prove not to be available from Europe, the next Irish Government [ i.e. the Fine Gael-led government] would -- in order to restore its own credit worthiness -- be left with little choice but to unilaterally restructure the private debts of those Irish banks in greatest need of recapitalisation."

This is an astounding claim. Or maybe it's a threat. Ever since the financial crisis started, only Iceland has actually chosen to allow bank creditors to eat their own losses. Save Iceland, every single government has, in one way or another, protected bank bondholders. And yet, here we find Fine Gael firing a shot across the bow, not just towards Ireland's bank bondholders, but at bondholders around the globe. Until now, Iceland has been an outlier, the exception that proves the rule (the rule that protects bank bondholders at all costs). However, that could change quickly.

If Ireland also moves to force a haircut on bank bondholders, we may see other countries follow suit, with some reneging on their own sovereign debt (think Greece). Haircuts for bondholders are likely to happen because they are both politically popular, and because many nations (like Ireland) are simply unable to service the debt load that has been foist upon them. Writing in the Irish Independent just yesterday, Brendan O'Connor quotes a friend who works in the financial markets who had this to say about the Irish government's plans to pay off their banks' debt:

• "They look like f**king eejits paying it off. This is a game, and they need to start playing it."

O'Connor goes on to say,

• "This is a guy who knows private sector bondholders backwards. He has worked with them for years in mergers and acquisitions and he points out that haircuts are an accepted part of the game when things go wrong. And not only will the big private equity houses like Blackstone and KKR accept a haircut when things don't work out, they'll be back again to fund the next merger or acquisition. Because it's just part of the game. You win some, you lose some, but you don't stop playing just because you lose now and then."

Irish politicians have been way behind the ball on this. The idea of giving haircuts to bank bondholders is a part of the public discourse now in countries like Ireland. And more and more it's becoming a central political issue. When I was there this summer, many people still didn't realize that the bailouts were for the benefit of bank bondholders. At this point, after all the protests and debate over the IMF bailout of European banks, I would venture that things have changed considerably -- most Irish people are now well aware that they are being sacrificed for the likes of Goldman Sachs and Soc. Gen.

Expect more developments in the coming days and weeks.

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