Spain’s plan to rid banks of toxic real estate assets is reviving the politically heated debate over how creditors and taxpayers should share the vast losses still being incurred by the Euro zone debt crisis. Nowhere is the issue in sharper relief than in Ireland.
The Irish government took an 85 billion Euro IMF/EU rescue package to bail out the country’s banks, felled by a reckless decade-long building boom, and extended a blanket guarantee to 440 billion Euros of the banks’ liabilities, including senior bonds.
As a result, Ireland’s total debt soared from 44% of GDP in 2008 to 106% last year, according to the International Monetary Fund.
The overriding reason why Dublin cannot bow to public calls to “burn the bond holders”, even if it wanted to, is simple: the European Central Bank would not permit it.
ECB is worried that imposing losses on senior bond holders in one country would instantly spread contagion throughout the 17-member Euro zone.
So Iceland, not in the Euro zone, could snub the creditors of its failed banks; Ireland could not. This experience colours the advice that Irish academics proffer to Spain, which is hoping to cleanse banks of their sour property loans without adding to a public debt burden that is already so high that some investors believe Madrid too will need aid from the IMF and European Union.
“Resolve the banks if you have to and don’t get forced by the ECB into paying 100 cents on the dollar to bond holders in banks that are bust, which is what we were forced to do,” said University College Dublin economics professor Colm McCarthy.
The ECB fear that forcing losses on bond holders would rattle markets was borne out to a large extent during last year’s negotiations over a second IMF/EU rescue for Greece.
After months of saying no, the ECB relented in July and accepted the need for holders of Greek sovereign bonds to take a 21% write-down. Soon after, the government bonds of Italy and Spain came under heavy pressure.
“The ECB would say the same would happen to the senior bond market. You’d kill it for a long, long time and they’re anxious to avoid that,” said Alan Ahearne, a professor of economics at the National University of Ireland in Galway.