Euro crisis: “The avoidance of such a meltdown must be the over-riding interest of both Ireland and Europe now”

I’m not entirely convinced that the “strongest argument against a State default has disappeared” completely, but in the Irish Times Dan O’Brien provides the rationale behind the argument against a default in the short-term

It is no longer in Ireland’s narrow national interest to prevent senior bondholders from suffering the consequences of their own bad judgement.

But this is very unlikely to happen, in the short term at any rate. That is so because a consensus exists among European policymakers regarding the extremely weak and fragile state of the Continent’s financial system.

It has been based on a view that the system might not survive the direct and indirect effects of a default shock – the direct effect would be tens of billions of losses distributed across the system and the indirect effect would be panic as other bondholders realised that their government-backed protection had been removed.

This consensus is also informed by how, in hindsight, the US authorities grossly underestimated the effects of allowing Lehman Brothers to default 26 months ago; by how Europe’s financial system continues to function owing only to massive government support; and by the fear that there may not be enough additional government resources to keep the system standing in the event of another shock.

This view underpins the policy of preventing both banks and countries in the euro zone from defaulting on their debts since the crisis erupted.

It must be stressed that nobody can know for sure if this consensus is correct in general, and in particular what would happen in the event of a default on Irish senior bank debt.

But they are real risks, and policymakers are very much in the risk-management business now. They must consider the probability of an event happening and the impact it would have if it did happen. As the risk associated with large-scale default is high and the impact potentially massive, Europe is taking a cautious, if very costly, approach.

Just how costly that approach will ultimately be is one of the known unknowns.  And not just in terms of Ireland’s four year plan…

But as the BBC’s Gavin Hewitt pointed out

Bail-outs focus on the short-term.

They are firefighting. They buy time. They help countries to manage their debts in the here and now.

They can keep at bay the harsh verdicts or judgements of the financial markets.

What they don’t do is address the basic problems of any particular economy or the fundamental flaws in the single currency.

And there are fundamental problems in the eurozone still to be resolved.

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  • David Blake

    If it is true that the narrow self-interest of Ireland argues in favour of forcing senior bond-holders to take a loss but the broader interest of European banks requires they do not, the broader European banking system should pay, not Ireland. This is not the time for Ireland top be bailing out Germany.
    Whether it is legally possible to do this in the light of the very foolish prmises made by the Irish government is another matter.

  • DC

    The financial markets provided unneccessarily heavy steriodal credit shots over the last 7 years into the arm of many economies, but with such economic body-building comes the vital requirment or much needed accompaniment – protein and a lot of food.

    Unfortunately, the protein is export-led production and the food is the bread and butter of the proper economy – and it is this – the growth rate of the real economy – which is open to question.

    The economies should never ever have had those steriodal shots, especially not at such high doses.

  • DC

    *steroidal

    the steroidal has become a bit haemorrhoidal?

    anyway…

  • Anon

    The US allowed a disorderly default of Lehman. No one is suggesting a full scale bankrupt the country and damn the consequences route. The system could well survive some form of controlled burden sharing leaving Ireland in a position where it’s debts aer manageable.

    As it is: debts that can’t be repaid won’t be. Europe can acknowledge this now or later.

  • Brian Walker

    If Ireland went for full default who would lend to them again? There are plenty of other takers. Dan’s argument is surely circular and begs the question. So they should think about default but only after stability had been reached? But stability would not be reached if they were going to default straight after. All the signs are that no country is being to be given permisison even on a nudge, nudge basis to default because of contagion. If they told barefaced lies, that would surely make matters even worse.

  • Anon

    Perhaps the same people who lent to Russia, Argentina, Iceland..,, after they defaulted. default si a sunk cost to investors. Ireland would pay a penalty for a while and then be allowed back on the markets. Especially if they show commitment to never allowing it to happen again.

  • percy