Back To Business, Emmet Oliver - Forget NAMA...

...what the government and the opposition parties need to really decide is whether they want to mess with powerful bond holders who hold billions of euros of liabilities in the main banks

Brian Lenihan has fiercely opposed a radical plan by Fine Gael's Richard Bruton to make bond holders take some of the pain of bank losses

Richard Bruton

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As economists dance around the head of a banking pin and legal draughtsmen disappear down a Nama black hole, its worth remembering that the only thing which really matters when it comes to discussing the bank's loan losses is on whose desk the final bill lands.

The size of the bill is terrifying. Domestic banks are expected to incur loan losses of at least €25bn in the period 2008 to 2010. Even slightly more conservative property lenders like Bank of Ireland are looking at property bad debts eating up 141.7% of their profits this year, with 134.5% being eaten away next year. The country is definitely going to have to live with loss-making zombie banks for several years, but only for government infusions we'd be living with insolvent banks.

Since the bank guarantee scheme was agreed on September 29 the government has ploughed ahead with the general idea that the loan losses must ultimately be borne by the taxpayer, although it has sought to reduce the exposure by demanding a coupon on its preference shares and a Nama clawback which allows the government to apply a bank levy if Nama doesn't end up making a profit.

Whether the government nationalises all the covered banks or sets up a Nama in isolation while leaving the banks in private hands is not the crucial issue. The crucial issue, which government representatives either are unwilling or just reluctant to discuss, is how the losses, all losses, from soured bank loans are to be distributed.

So far they have been distributed among banking shareholders via reduced market valuations for their stock and an end to dividends. For taxpayers the losses have been distributed via the guarantee scheme and the preference share investment.

In the case of shareholders they have already had to forgo income on a massive scale as part of the loss allocation. That is how the credit pyramid works, shareholders take losses up front, creditors later, if at all.

But no credit manual for banks specifically insists that taxpayers are next in line to shoulder losses, before bondholders, secured or unsecured. International bank rescues have clearly evolved that way in the last 12 months, but forcing taxpayers second in line to mop up the losses, after shareholders, but crucially ahead of bondholders, remains very uncapitalist.

Fine Gael in probably its most radical financial proposal ever is now suggesting that Ireland alone in the world should make at least some classes of bondholders absorb losses ahead of the taxpayer. The government calls this glib populism and capital markets veterans like to call it naive. Many worry that any attempt to shove bondholders into the loss absorbing chain will only hugely increase the funding costs for Irish banks and the Irish state.

The problem is nobody really knows- Ireland Inc or an Irish bank has never defaulted on any bond debt before. Many would argue now is not the time to start, just as Ireland is starting to convince the bond markets of our fiscal bona fides. But it would be helpful if the main parties, the banks and economic commentators could start at least addressing the issue of who should be absorbing the losses, rather than having obtuse conversations about how Nama will work.