Time to Stop Leaving the Economy to the Economists

Published in the Evening Echo today:

A Citizens’ Assembly is a forum where people get to inform themselves on particular subjects, deliberate on them, decide a course of action, and perhaps see that decision implemented. Citizens’ assemblies have worked in British Columbia and Ontario, Canada, in Iceland, and in Australia.

Part of any citizens’ assembly will be a discussion of the economy: how we got here, what our biggest challenges are now, what decisions we can take, and the likely outcome of those decisions. It will take the citizens’ assembly about 43 seconds before someone mentions burning the bondholders. This article looks at both sides of that argument.

A new IPSOS MRBI Poll conducted for the UCD national discourse project has shown that a fairly even distribution exists between the 31% of respondents those who would like or very much like to ‘burn’ the bondholders, and the 25% of respondents who think Ireland should honour its debts to maintain its reputation abroad. Fully 41% of respondents didn’t come down too strongly on either side. This reaction is in contrast to the respondents’ clear preferences for expenditure cuts rather than taxation increases in the same survey.

Uncertainty around what to do is understandable. In fact, uncertainty is the key problem we want to address. But first, let’s inform ourselves.

What does ‘burning the bondholders’ mean? A bond is a legal contract where you promise to pay back money you’ve borrowed today at some point in the future, usually with some payments of interest in the meantime.

Governments, banks, and businesses often issue bonds. When banks and businesses get into trouble and become insolvent, and can’t pay back their creditors, the business is either wound up or put into receivership, or restructured. Part of the restructuring involves writing down the value of the assets of the company. Writing down assets means the people who lent the business money don’t get all of their money back.

Sovereign nations – unlike businesses and banks – can’t be liquidated. Defaulting, or restructuring, enables debtor countries to reduce the size and/or lengthen the maturity of their repayments. When governments, banks, and businesses do this, they are burning bondholders.

‘Burning a bondholder’ means not paying people back everything you borrowed from them in the form of bonds. You can pay them back, say, 80%, or 20%, or nothing at all. It depends on how bad things are.

There are two main types of bondholder. A senior bondholder has a higher credit rating than a subordinated bondholder, meaning if things go wrong the senior guy gets paid first, the subordinated guys might lose out.

Today in Ireland senior bond debt is regarded as the same as deposits in banks, and almost the same as sovereign debt. When you burn AIB’s bondholders, it will have an effect on Ireland as a whole, because the Government of Ireland guarantees the liabilities of most of the banks.

What would be the effects of burning the bondholders? On the positive side, Ireland wouldn’t have to pay back the debt it has guaranteed. There are roughly 43 billion euros worth of unsecured senior and subordinated debt out there now. Say we only pay back 50% of that 43 billion euros. Ireland can spend the other 21.5 billion euros on increased social services, or lower taxes, or paying back some of our other debt. There is an element of social justice at play here as well, in that people who took risk in the hope of return don’t get their investments back, and aren’t rewarded for their failures by taxpayers. The act of burning the bondholders would reduce uncertainty about how Ireland is going to pay these people back. With the total stock of debt fully known, Ireland can go about paying down that debt over the next decade or so.

On the negative side, any restructuring or default of bank debt might exclude Ireland from future borrowing, and would, at the very least, result in higher borrowing costs from international markets. Remember that Ireland needs to borrow to make ends meet. Markets have a fairly long memory when it comes to sovereign debt, and so Ireland might face a decade or more where it would be difficult to borrow money from abroad. Argentina and Ecuador still find it hard to borrow. The Irish economy would stagnate as credit dries up even more.

There are also broader costs to default. Investment from abroad might fall because investors are uncertain about future trade with Europe. A default would trigger another banking crisis, and probably weld us further into the EU, as we would become a ward of the European Central Bank. Overall, economic output might fall further. There is the worry of a contagion effect, where Ireland’s actions have knock on effects in other EU countries, collapsing the Eurozone banking system.

A citizens’ assembly would hear all the arguments for and against a default on bondholders. Whatever they decide, it would inform policy, and create a set of highly informed citizens. The initiative is to be welcomed, mainly because it wouldn’t leave the economy to the economists.

Read more at Steven Kinsella