April 5, 2010
The reason Anglo Irish Bank should be let go is simple: defaulting now will make no difference whatsoever to Ireland’s economic performance in the future. In contrast, keeping it on life support will cost us dearly. So shut it down and repudiate the debts.
The reason I am so sure that this will work is that, unlike most people making the decisions in Ireland, I worked in the defaulted debt market in the 1990s. I was the economist in a trading team at French bank BNP, which restructured defaulted debts, found new buyers for these debts and, in so doing, opened the door to those defaulting countries so they could come back into the international fold.
As far as I am aware, none of the people who are maintaining that we cannot default and must write a cheque to pay for Anglo’s misadventure have any such experience of working in defaulted debt markets.
The lesson is that the financial markets always forgive countries that default. There is always a deal to be done and, while it is not pleasant and negotiations can get heated, deals are done.
I worked in what was called the Brady bond market, which was a scheme hatched by US treasury secretary Nicholas Brady.
The Brady bond market was an enormous multibillion dollar market which financed and nursed back to health countries that defaulted in the 1980s and 1990s.This market flowed from deals done by defaulting debtors and their creditors.
For all the warnings of disaster, the banks realised that it was not in their interest to shut out Russia, Brazil and Mexico indefinitely. Banks always finance opportunity, so while they might not like being defaulted on, they see this as part and parcel of the game of capitalism.
This is why the idea of co-responsibility is so fundamental to a market, the lenders are as culpable as the borrowers and the taxpayer has no business getting involved.
This is why we should let the guarantee lapse and do a deal with all the creditors of AIB and, in the case of Anglo, simply default and force the creditors to come up with a ‘take it or leave it’ deal. We can also sell the deposits of Anglo to one of the bigger banks to protect depositors.
If you are worried about such a course of action and are persuaded by the rhetoric of the government, let me show you how debt default is not the end of the world. Let me show you how things can change and how yesterday’s defaulter becomes tomorrow’s star.
Goldman Sachs – the most powerful bank in the world – says that four countries will dominate the next 20 years: Brazil, Russia, India and China. Known as the BRICs, they are the stars of tomorrow. This is now received wisdom in much of the financial markets. But it wasn’t always like that.
Ten years ago ,two of these countries were regarded as basket cases that would never fulfil their potential after they defaulted. Brazil and Russia were regarded momentarily as pariahs. What if I told you that just over a decade ago, the team I worked with bought Russian bonds that were trading at 7 cents on the dollar.
What if I told you that we traded Brazilian bonds at less than 30 cents in the dollar? What if I told you that within four years these bonds had been redeemed at par?
All this happened and no one thought of what was said before or during the defaulting crisis when prices started to rise again.
Before the default prices collapsed but once the countries actually defaulted, the markets concluded that phase was over.
The ‘event’ had happened and then money flowed back into the countries enabling the countries to recover.
Now, ten years later, these two former pariahs are stars and destined to inherit the future. And what happened to the investors who lost money in Russia and Brazil? Many of them licked their wounds, wrote off the losses and got back in for the new ride, hoping to make money in the upswing to cancel out the losses they made in the downturn. That’s how capitalism works.
Financial markets are forward-looking. For the investor, it is always about tomorrow and there is always new money for the right investment. The idea that the world will shut the door on a country in trouble is so false as to be laughable. This is not how the financial markets work. Unfortunately, the people warning us of armageddon if we let Anglo go have no experience of the defaulted debt markets and, thus, really don’t know what they are talking about.
What is particularly galling is that in many cases the people saying there is no alternative to bailing out Anglo are the same establishment and financial markets figures who reassured us that the property market would achieve a soft landing and that the Irish banks had been ‘stress tested’ against a property collapse anyway.
They hadn’t a clue then and it would be the height of stupidity to believe them now.
When President Franklin Delano Roosevelt, in the middle of the Great Depression, took the US off the gold standard and defaulted, the warnings were that this would bring the entire American economy down. Roosevelt was aware of the arguments, but defaulted anyway. By taking the US off gold, he was saying to the creditors: ‘‘you will no longer be paid in gold but in dollars.”
At the time, the lawyers, civil servants and bankers forecast chaos and mass panic in the US. In the event, the opposite happened. The day the US default was made legal, the financial markets rallied, the Dow soared and the bond market rallied.
Why did this happen? It happened because forward-looking investors realised that the US would be bankrupt if it tried to pay all the bad loans on the banks’ balance sheet and therefore, it was better for everyone that it took the pain now and lived to fight another day. Guess what? The US recovered and no one mentioned the default again.
The same will happen here. The financial markets want to see that Ireland is going to grow again. They want to invest in us, in our real abilities, the abilities of the people. Therefore, they want to see a strategy for growth. What they are seeing now is an illegitimate strategy, with no public support, which will turn Ireland into a large debt-servicing agency.
The problem with this is that so much debt undermines the potential of the people and risks yet another debt crisis. As a result, the money that could be invested in Ireland will stay away because the risk in Ireland has been heightened – not reduced – by Nama and the government’s banking policy.
The markets want to see the government giving the people of Ireland a chance. If that chance is facilitated by a default, the markets will support us. Investing is, like a second marriage ‘‘the triumph of hope over experience’’; we quickly forget the messy divorce and move on, armed with the hope that next time it will be better.
The history of bank defaults, repudiation and renegotiation reveals that human nature doesn’t really change. We march into the future full of confidence despite recent experience, because that is what humans do.