17 July 2012

FT: Draghi's salutary change of heart

It is a potential watershed in the crisis that ECB president Draghi is now coming round to the point of view that Europe needs tools to write down the claims of senior unsecured creditors to failing banks – and the courage to use them when necessary.

The case for writing down senior bank bondholders when losses outstrip shareholders’ and subordinate creditors’ ability to absorb them is straightforward. A bank’s promise to its creditors is a private matter: investors are paid for the risk that they voluntarily take on. A government which, like Ireland, bails them out with taxpayer funds, indentures its citizens for the benefit of private interests. Banks may have to be kept alive for the sake of the financial system’s survival – but a state that cannot restructure the banks’ debts in the process is in an intolerable situation.

So it is a shame that Mr Draghi did not convince his eurogroup colleagues to permit senior bond writedowns. This was a serious shortcoming of an otherwise promising bank restructuring plan for Spain.

If crystallising the shortfalls in Spanish banks means the losses are more than junior investors can cover, who will take the hit? It is too late to save Irish taxpayers, though the rest of Europe could share the burden. In Spain, things can still be done right. Mr Draghi deserves a wider hearing.

Full article (FT subscription required)

© Financial Times