From Niels Jenson’s latest Absolute Return letter (via PragCap), a good explanation for why the new Irish government led by Fine Gael’s Enda Kenny may really be able to push through a bond haircut:In reality, though, the Irish have a stronger hand than generally perceived. With their banks sinking faster than other European investors can offload their exposure to Ireland, what would Ireland actually lose from calling the EU’s bluff and let bondholders take a haircut? Perhaps even walk away from the euro and go back to the punt? Usually, one of the strongest arguments against leaving a currency union is the inevitable run on the banks. But if the bank run is already in full bloom, that argument loses much of its power.
If the deposit drain continues at the current rate, the day will soon come where the price of leaving the euro will no longer be punitive. At a minimum, the new Irish government should push aggressively for a renegotiation of the rate of interest it pays on the emergency funding. At 5.8% there is plenty of scope for improvement of terms.
After all, the EU’s main concern is not Ireland. No, what the EU is desperate to maintain is the illusion that the EU’s banking sector in general, and Germany’s in particular, is sound and healthy. In reality, the German landesbanks, together with the Spanish cajas and the Austrian banks, are amongst the weakest in Europe in terms of their capital base, and the German banks have plenty of exposure to Ireland. In other words, keeping Ireland afloat is a critical part of Merkel’s strategy to keep its own banking sector alive. This very fact, which the German government is doing everything in its power to conceal, provides Ireland with a once-in-a-lifetime opportunity to renegotiate its borrowing terms.