Bondholder Betrayal Leaps Anew

From Mark Grant, author of Out Of The Box

Betrayal Leaps Anew

America is not virginal; I will start out with this statement as exemplified by what was done with General Motors and the ending of the dividends for the owners of the Freddie Mac and FNMA preferred shares. Fortunately Mr. Paulson is no longer in a position of power as his decision making process was seriously flawed in my opinion. However, having owned up to previous mistakes, the Rule of Law still generally functions in the United States and bankruptcy proceedings follow well documented procedures so that while America cannot claim perfection it can claim a record that is significantly better than Europe. I begin today’s discussion from this point as life is often a matter of degree and very few things are just black or white and the shades of grey is the vast area where most things make a difference. Then, having admitted the mistakes, I find what is transpiring in Europe to be of particular concern to bond holders.

“He that has eyes to see and ears to hear may convince himself that no mortal can keep a secret. If his lips are silent, he chatters with his fingertips; betrayal oozes out of him at every pore.”


                          -Sigmund Freud

You may recall that the PSI (Private Sector Involvement) was a one-off event as heralded again and again in the Press by every political leader in the European Union. This proclamation was thundered from the rafters, held up like a banner by the ECB and trumpeted by every Parliament in Europe. The message was clear and rolled out like a red carpet for bond owners, “This will never happen again.” Amazingly, or perhaps not so, is the length of time that “never happen again” took to dissipate. The European Union and the European Central Bank are now signaling a change of position as tax payers always trump the owners of bonds and I fear one more example of this is about to be shoved down our throats. Mr. Draghi’s recent statements are all but a fait accompli in my opinion and you may expect some definitive announcements very soon. The situation is even more grave than this however as the question of “seniority,” already a distressing issue, is also going to be re-addressed and I think recalculated in some very non-conventional ways so that an owner of senior debt in European sovereigns and European banks will find himself behind an eight ball with absolutely no control and in serious jeopardy.

Draghi, in his talks with the Irish Finance Minister, “noted that the question of burden sharing with senior bond holders is evolving at the European level, through ongoing discussions on an EU Resolution Directive.” The ECB said in a statement released yesterday said that Draghi “expects that these developments will be reflected in the Irish adjustment program.” Irish government officials said last night they were anxious to “explore avenues not open to explore” at the time of Ireland’s bailout.

We already know, in the case of Greece, that the ECB, the EIB, the IMF and the European Union have senior positions and were not forced to take losses along with private bond holders. This was done by fiat and very little legally was needed to accomplish this task. During this fiasco we learned the lesson of “local law bonds” and I am afraid that this lesson is about to be foisted upon us once again. As negotiations proceed in Ireland and as a lot of Irish debt has been shifted from various European banks to the ECB we may soon see that the senior debt of both the sovereign and of the Irish banks may become the next Waterloo for bond holders as another PSI is rolled out and as various European institutions claim precedence. This could also be on the table for Portugal and her banks, for Spain and the banks domiciled there and even for Italy. The scent of danger is certainly in the air and various comments made by the political leaders in Europe seem to be indicating a change of plan that will shift the burden from taxpayers to the holders of debt and it may be imposed in some very unconventional ways given what the EU has done to date. The reason is simple enough; lessen the debt of a country and her banks and have the bond holders pick up the tab as it is no longer politically feasible to have the other nations of Europe foot the bill. The monkey is about to jump from the citizens’ backs and onto ours and I suggest a well measured retreat now before the antics of the monkey begins.

“I am not retreating, I am advancing in a different direction.”


                   -General Douglas MacArthur