The elephant in the room - bond market markdowns

The elephant in the room is the determining who will or should take the credit losses from an adjustment in bond markets from a sovereign crises. The uniqueness of the Ireland crisis is that the credit problem was not from public finances but from private financing and credit expansion. Greek had terrible public finance. Ireland was running a balanced budget just a few years ago. The crux of the Ireland problem was the bail-out of the private banks which engaged in excessive credit expansion in a low interest rate environment caused by the ECB. There was no choice given the central bank controls a single rate for the entire EU.

What should have happened was a write-down in the debt of Irish banks. In fact, it is not clear that Ireland needs their own banks given interest rates are controlled outside of the country. So what would happen if just allowed the bank debt to be written down to zero or have to go through a bankruptcy proceedings. Each of the holders of the bank debt would take a loss. The issue would then be whether governments would want to bail-out the bond holders of their countries for holding debt in other institutions. If German or French banks were holding a high percentage of the Irish debt, they would take a loss and it would then be up to the German or French governments to decided whether there is a need to help their banks.