Barry Eichengreen has some deservedly sharp words for European Commission, the European Central Bank, and the German government over the Irish “rescue package.” Likening it to the punitive reparations burden imposed on German at the end of World War I, Eichengreen points out that the bailout does not, in fact, reduce Ireland’s debt one bit, but merely “kicks the can down the road,” leaving it for future Irish governments (and taxpayers). The result leaves Ireland open to the type of debt-deflation spiral that Irving Fisher wrote about during Great Depression.
Eichengreen suggests that rather than insulating bondholders in failed/nationalized banks, they should be forced to accept some loss.
There is ample precedent for this.
During the financial crisis of 1848, the Schaaffhausen Bank of Cologne—the Rhineland’s largest private bank—was forced to suspend payments. In bailing out Schaaffhausen, the Prussian government converted the private Schaaffhausen into an incorporated bank (Schaaffhausen’scher Bankverein), and its creditors into shareholders. Half of the new shares were guaranteed to pay an annual dividend of 4.5 percent, plus back payments of 10 percent per year until 1858. The other shares were not guaranteed, and were to pay no more than four percent. The shares remaining to the original owners were not to pay more than two percent through 1858. The bailout also gave the Prussian trade minister the power to choose one of the bank’s three directors.
This approach could have been adopted in the Irish case. And it can be adopted when the next bailout comes along, as it no doubt will.