Irish Bank Crisis Going Global



Rick Newman, On Tuesday November 16, 2010, 5:49 pm EST

You may not have to worry about Ireland in a week, or a month. But at  the moment, the Emerald Isle is causing global investors a whole lot o’ anxiety.

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On the  surface, it’s reminiscent of the problem Greece had with its  unmanageable federal debt early this year, which shook world markets,  ended a global rally in stocks and ultimately led to a $146 billion  bailout by the European Union and the International Monetary Fund.  Greece spent more money than it took in for years, papered over the gap,  and essentially became insolvent when it could no longer borrow the  money needed to finance its debt.

Ireland is  on the brink of insolvency too, which has helped drive down the S&P  500 stock index by nearly 4 percent over the last few days. But unlike  Greece, Ireland is a relatively wealthy country, with per capita GDP of  nearly $38,000. That’s 21 percent higher than per capita GDP in Greece,  and in the top third for European countries. Low corporate tax rates and  a skilled workforce have made Ireland a haven for some of the world’s  biggest companies. And its public debt, about 65 percent of GDP, is far  below Greece’s crushing load, which is 126 percent of GDP. Ireland’s  debt levels are even lower than those in France, Germany and the United  Kingdom.

But Ireland has one huge problem that  may soon make it a supplicant to its European brethren: A failed banking  sector that Ireland’s government can no longer rescue on its own.  Ireland is in the midst of a real estate bust that could trump even the  ruinous downturns that turned parts of southern California and Nevada  into suburban ghost towns, with home-grown banks stoking it all. Now,  those banks are trying to manage catastrophic losses. The Irish  government has effectively nationalized the nation’s biggest banks by guaranteeing their debt, which would be  akin to the U.S. government taking over Citigroup, Bank of America, J.P.  Morgan Chase and Wells Fargo.

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That  means the Irish government is also on the hook for the losses those  banks endure–which have risen far beyond initial estimates, and may have  a lot farther to go. So far, the Irish government is obligated to cover  losses amounting to 175 percent of Irish GDP, which is becoming an  unsustainable burden. “If the Irish banks go down, the Irish government  also goes down,” says economist Jacob Kirkegaard of the Peterson  Institute for International Economics.

As  estimates of Irish bank losses have gone up, pressure has mounted on  Ireland to do something decisive–and panicky markets may now force a  solution. Ireland wants the European Central Bank to continue lending  money to Irish banks at low interest rates, but the ECB has different  ideas. Inflation has been creeping up in Europe, and the central bank  said recently that it wants to end its program of pumping liquidity into  banks, not continue or expand it. Cutting off those loans to Irish  banks could force defaults, which the Irish government would have to  cover or essentially be in default itself. Germany, meanwhile, wants to  hurry a bailout of Ireland, to prevent worries about sovereign bonds  from spreading to Portugual or Spain, which would be a much bigger  problem.

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A  European bailout of Ireland would be manageable, and probably cost less  than the Greek rescue. But Ireland doesn’t want it, because the EU and  IMF would force austerity measures onto the island nation that could  effectively end its appeal as a business-friendly nation with a high  standard of living. Since Ireland is wealthier than other European  nations that would essentially be lending it money, social programs  would end up gutted, and taxes would soar. And Ireland’s 12.5 percent  corporate tax rate–one of the lowest in the developed world–would almost  certainly go up, taking what’s left of the roar out of the Celtic  Tiger. If multinational businesses abandon Ireland, it could fall  quickly down the list of Europe’s most prosperous nations.

The standoff is what worries the markets, since a protracted  bailout battle darkens the clouds over Europe’s other deeply indebted  nations. Portugal and Spain aren’t in serious danger of default at the  moment, but as Ireland’s cost of borrowing goes up, so does the cost of  borrowing in similarly stressed nations. That gets passed through to  businesses operating in those countries that do need to borrow money–and  they could face more urgent funding needs than their own governments in  the weeks ahead. That’s how Ireland’s problems ripple outward to other  indebted governments, the real economy and ultimately to the global  stock markets.

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A bailout might seem tough to swallow in Ireland, but it would  most likely calm global markets. Moody’s Analytics points out that  there’s plenty of money available for a bailout, and also that the  ramifications of a sovereign default are so severe that even  nationalistic politicians would never let it happen. “We still believe  the probability of default by a euro zone member state within the next  two years is not significant,” Moody’s wrote in a recent analysis.

Kirkegaard of the Peterson Institute sees three  possible options. One is that a large bank, probably in Asia, could  sweep in and buy up the Irish banks, if it got sufficient guarantees  against losses by the Irish government. Prognosis: Unlikely. There’s  also a tiny chance that the European Central Bank will change its policy  to accommodate Ireland. But that’s even more unlikely.

What’s most likely is some kind of Irish bailout, with tough  negotiations over when it happens and the conditions Ireland must agree  to. Ireland will fight hard to put off a bailout–at least until  parliamentary elections on Nov. 25–and to retain its right to make its  own fiscal decisions. But Ireland’s luck may be about to run out, with  other European nations likely to insist that Ireland face austerity  measures at least as tough as those in Greece. Maybe tougher. “That  would have very signficiant long-term growth implications for Ireland,  and other euro zone countries know that,” says Kirkegarrd. “But given  the politics of bailouts, that simply doesn’t matter.” After all, there  may be other bailouts that need to be addressed.

Copyright 2010. All Rights Reserved


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