The debt market is increasingly betting that the government will simply have to force losses on some of those holding up to €4.9bn of subordinated bonds in Anglo Irish Bank, the lender that posted the largest loss in Irish corporate history a fortnight ago.

Credit default swaps, a form of bond insurance, raced ahead on subordinated bonds of Anglo Irish late last week. The swaps, a key measure of credit risk, were at the elevated level of 1,090 basis points, one of the highest rates of any bank in Europe. This means someone purchasing these bonds in the secondary market would theoretically have to pay $1m to insure $10m worth of bonds.

Moody's last week suggested holders of these junior securities could be facing losses as interest payments are deferred by possibly several Irish banks, but most likely Anglo Irish. The government has been reluctant to discuss this possibility, but its public stance is that all bond-holders will be paid, at least for now.

Instead it plans to buy back certain subordinated bonds of Anglo Irish at a discount which has yet to be disclosed. But Moody's last week said the deferral of coupon payments was the key concern for investors to watch.

Anglo Irish has a range of subordinated bonds, from perpetual securities to step-up notes. Some have floating interest rates, others are fixed. A large number of them are priced in sterling or dollars. Most of the dated bonds have long maturities running to between 2014 and 2017.

The subordinated bonds are held mainly by European pension funds, banks and asset managers. Among those holding them are HSBC, Nordea Bank, DWS Investments and US fund Capital Research. Sean FitzPatrick, ex-Anglo chairman, invested in a dated subordinated bond maturing in 2017 with a face value of €750m. However FitzPatrick's slice of this bond is tiny.

Moody's said last week the "risk for potential losses has heightened stemming from coupon deferrals due to the potential for protracted losses" at Irish banks. However it also raised a second fear that the EU could prevent future state aid for banks unless some bond-holders are forced to share some of the losses.

The government, while exploring the deferral of payments, is extremely worried about a backlash from the bond market. It would prefer to take any action against bond-holders under a European umbrella if possible. Fine Gael has a more radical plan to force bond-holders to accept losses after several banks go into bankruptcy proceedings.