Myth: Bondholders will not accept a default

When Irish bond yields were widening and the interest rates for Irish government debt were increasing in October and November, we heard a lot about how the bondholders will not accept a default on Irish debt. Here is Damian Chunilal of Hong Kong-based Ocean Capital Management on October 25:

If the Irish Government breaks its commitments to support Anglo senior bondholders, why would investors believe its similar commitments given to Allied Irish Bank, Bank of Ireland or indeed with respect to the sovereign state itself? 

We are told there will be dire consequences for the state if Anglo's bondholders are not covered by a general guarantee of their funds. But Anglo bondholders accepted a reduction of 80% on their debts in late November. Of course, bondholders do not walk into risk blindly, even though they hope to make a profit. Just in case they don't profit, they take out insurance against their losses. Unlike people living in Ireland, they can ask Goldman Sachs to sell them this insurance in case the loan is not paid. Why then is similar protection afforded to all of Ireland's banks? Because in September 2008, the Irish government decided that no loss to any of the banks' bondholders could be tolerated. This is a decision by politicians. As Michael Taft has pointed out:

Too many of our commentators listen to 'salesmen' and pay too little attention to what is actually happening in the markets.

Cutting welfare and wages did not work in 2008 and 2009. The bond spreads still went up and up.

So why continue now to attempt to meet seemingly insatiable market demands?