Irish bonds downgraded to “junk” status – why you should really take another look.

Susan
By Susan July 13, 2011 21:01

Irish bonds downgraded to “junk” status – why you should really take another look.

On Tuesday, credit ratings agency Moody’s announced that it had decided to downgrade Ireland’s rating to “junk” status.

Who do they think they are, you say, and what business have they calling us junk ?!

What job does a US credit rating agency have downgrading Irish bonds? Who are they anyway?

Moody’s decision to cut Ireland’s ratings has been harshly criticized. In fact, the EU called for a ban on rating agency decisions concerning countries that are putting together an internationally approved recovery plan.

Indeed, such ratings make it more difficult to implement the recovery plans, by depressing the bond market. This in turn makes it increasingly difficult for a country to borrow external finance, independent of the IMF & the EU. So why did Moody’s take that decision?

As a credit rating agency, Moody’s job is to inform market participants about the quality of bonds. Investment managers and pension funds cannot gamble their money: this money belongs to thousands of “little people”. And lenders will often not accept junk bonds as collateral for a loan.

So credit rating agencies give valuable information to fund managers – the people who manage your money!

But why such an offensive word? And what is a junk bond?

An unfortunate choice of word if ever there was one, especially when we Irish are on the receiving end! By calling Irish bonds “junk”, though, Moody’s are essentially saying they are no longer “investment grade”.

As a result, you are taking on further risk if you own those bonds, but this comes with a possibility of higher return. When conservative holders sell their Irish government bonds since they are no longer “investment grade”, this drives the price downwards. Consequently, the yield increases, and if you buy this government bond then, you will increase your return.

All sound good? There is just one thing! Moody’s opinion is that, given current circumstances, Ireland might default on its bonds. This means that the loan might be paid back later than first agreed to, or with a lower interest rate, or no interest at all.

Private creditors will be affected by this and will have to bear the brunt so as to make it easier for the country to pay back its debts. Such private creditor involvement is being advocated to help Greece secure a bailout.

And if Greece creates such a precedent, Ireland might follow the same path if it needs to, to make it easier to recover.

Just when we thought we were doing better! It’s not fair…

Maybe you shouldn’t worry too much, though: yes, Ireland’s situation is still preoccupying and we’re far from having recovered yet. But necessary reforms are being implemented and, as a country, we’re working on a solution…

The EU has tentatively accepted to make conditions for the bailout more flexible, by lengthening the period before Ireland has to pay back its loans, and by lowering interest rates, among others. In other words,  subject to ratification by national parliaments, they’re giving us some breathing room.

Also, Moody’s rating is an opinion. Consider it as a qualified statement: “Given the situation that is currently evolving in Europe, we consider that Ireland might behave as follows…”

Much ado about nothing, then?

Not exactly. Moody’s rating is a stern warning indeed. It’s only a warning, though. Other rating agencies, such as Standard & Poors as well as Fitches, have not downgraded Irish bonds, and still regard them as investment grade

Ireland might not, in the end, default on its bonds, or not as much as is feared. More importantly, countries belonging to the EU are working together to find a solution and to avoid any “domino effect” of a country going bankrupt and dragging others along with them.

For the first time since the beginning of this crisis, we saw some cohesion of thought last week in how to deal with what is a European problem, to quote AJ Chopra himself.

This is very positive indeed!

 

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Susan
By Susan July 13, 2011 21:01