Dan O’Brien in todays Irish Times explains why defaulting on senior bank debt or sovereign debt could bring down the whole European economy:
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According to the ECB, euro zone banks took losses of €515 billion between the onset of the crisis and mid-2010. These losses have blown a hole in the foundations of the European financial system.
Consider the sums involved. In the euro zone, banks have €5,000 billion in outstanding debt (the ECB does not break the figures down further, so how much of this is accounted for by senior bonds is not published).
There is almost as much weak country sovereign debt out there. The Greek and Irish governments combined currently have almost €500 billion in bonds outstanding. The Portuguese government owes approximately €150 billion. Spain owes about €700 billion – more than all three peripheral minnows combined. Italy owes close to €2,000 billion.
Put the Piigs public debts together and the sum arrived at is greater than the wealth 90 million Germans generate in a year.
Gradualists say that pointing to past examples of sovereign default – such as that of Argentina – is meaningless because a euro zone default would dwarf anything that has ever happened before.
Why talk of a unilateral default is hopelessly naive - Donal Donovan
( Donal Donovan was a staff member of the IMF during 1977-2005 before retiring as a deputy director. He is currently adjunct professor at the University of Limerick and a visiting lecturer at Trinity College Dublin.)
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*IN THE days leading up to the announcement of the IMF-EU agreement last Sunday, calls mounted for some form of credit default (or “burning of the bondholders”) to be part of the deal. The argument was simple – foolish lenders had contributed in no small measure to the problem so they should be forced to bear some of the cost.
Some had even suggested that since the bailout money would substitute for market financing, we would not have to worry about the adverse reputational effects of any loan default. But the clear statement from the IMF-EU representatives last Sunday that there is no question of any default being part of the agreement put paid to that line of thinking – which was hopelessly naive to begin with.
A major part of the whole deal, especially so far as the EU is concerned, is to try to restore market confidence in the euro area as a whole. Any talk of loan default right now is anathema to that objective…
Both Argentina and Russia, of course, suffered enormous reputational damage and their access to credit markets 10 years afterwards remains highly restricted.
The same, presumably, would happen in Ireland’s case – a point that the pro-default lobby would reluctantly accept (although they would argue that “eventually” the markets reopen for defaulters). But how have these countries been managing in the meantime? There were two critical features that distinguish their situations from that of Ireland.
First, both countries had independent currencies;…
Second, Argentina and Russia experienced good luck. Both depended heavily on primary commodities for exports and associated budgetary revenues. Primary product prices shot up in the years following the default and this provided a further major boost to growth and bolstered government taxes.
But these features are absent from the Irish economic landscape…*
and the pros…
*In all fairness, the position of others in the pro-default group can be interpreted as advocating a co-ordinated approach by the euro area as a whole to the issue, as opposed to a unilateral action by Ireland. This is a very different matter. We know that “burning the senior bondholders” has been ruled out until 2013 by the IMF and EU.
The current EU approach rests on the gamble that the problem can be contained sufficiently so that whatever bailout packages are required can be pushed though, despite public misgivings in contributing countries. But if the costs – probably involving more countries than currently foreseen – were to go beyond a certain level, the German taxpayer might run out of patience. Under such a scenario, and despite all the current assertions to the contrary, bringing forward the 2013 date in order to effect a haircut earlier would by no means be ruled out.*