Ireland Takes Over 2nd Bank as Bailout Bill Rises
In a sweeping action meant to regain the confidence of jittery investors, the Irish government said Thursday that it expected to inject billions of additional euros into two of the country’s largest banks, underscoring the extent to which they continued to jeopardize Ireland’s economic condition.
The announcement comes at a time of increasing fiscal duress for euro-zone economies, highlighted most recently by a French budget submitted Wednesday that was one of the most restrictive ever and a downgrade of the Spanish economy Thursday by the ratings agency Moody’s.
Still, in a neighborhood of stubbornly high budget deficits and expanding debt burdens, Ireland stands out. It now looks as if the cost to the government just for supporting its banks could reach €50 billion, or $68 billion, in a worst case scenario. That is by far the biggest bill that any country, outside of Iceland, has had to pay, relative to its size, as a result of the financial crisis.
According to Brian Lenihan, the country’s finance minister, Ireland will report a budget deficit of 32 percent of gross domestic product in 2010, after accounting for the government’s investments in its failing banks.
While the figure is a one-time charge — stripping out the banks, the deficit shrinks to 11 percent — it remains shocking and is the largest fiscal deficit recorded by a major European economy.
Driving the record figure was the government’s decision to take control of what was once Ireland’s biggest bank, Allied Irish, by investing as much as €5 billion to shore it up. The share offering would be state guaranteed.
With €174 billion in assets, Allied Irish has a branch network that extends throughout the country. It is also considerably larger than Anglo Irish, the failed lender that has come to epitomize the banking bust in Ireland.
As such, the decision to nationalize Allied Irish represents the acceptance of a stark reality by the government — that banking problems in Ireland did not lie just with Anglo Irish, but had contaminated the sector as a whole, so much so that there was no other recourse but for the state to step in.
The government also said Thursday that Anglo Irish might now require as much as €35 billion under a worst-case scenario. That figure equals an earlier forecast by Standard & Poor’s, one that at the time was questioned by government officials. Some Irish analysts said that the ultimate bill for Anglo could be even higher than that.
“They are getting there, but I still think that the embedded losses in Anglo Irish are €40 billion,” said Peter Mathews, an independent banking consultant based in Dublin. “They have not fully addressed areas like mortgage lending and loans to small businesses.”
Under a best-case scenario, the government would see its cost for bailing out Anglo Irish rise to €29 billion by the end of the year, officials said.
For weeks, the Irish government — the first in Europe to impose a harsh austerity regime — has been assailed by opposition parties as well as international investors for failing to admit that the cost of bailing out the country’s stricken banks was going to be significantly higher than official estimates.
As a result, the yields on benchmark 10-year bonds have soared to a recent high of 6.8 percent, causing concern that Ireland may be the first country to be forced to tap Europe’s €440 billion rescue fund.
The government has insisted strongly that it has no such plans to do so, arguing that it has raised enough money from the bond market to give it sufficient cash to last until the second quarter of next year. On Thursday, Ireland canceled bond auctions scheduled for October and November — sure to have been at elevated rates — and said it would return to the markets next year.
For the moment, investors have shown their approval. Yields on 10-year bonds narrowed to 6.6 percent Thursday, and the cost of insuring the country’s debt also decreased.
Both Anglo Irish and Allied Irish, along with most other Irish banks, indulged in a lending spree of historic proportions over the past decade, funding a property boom that went bust in 2007, with no sign of recovery in the market.
The government guaranteed all banking liabilities, including the senior and junior debt of the banks, a promise that has fed a slow burn of anger in Ireland among the many who feel that bondholders, as well as Irish taxpayers, should pay the bill for the bank’s excesses.
On Thursday, Mr. Lenihan said for the first time that junior bondholders in Anglo Irish would be expected to make a “significant contribution to meeting the costs of Anglo.”
However, in an interview with the Irish national broadcaster RTE, Mr. Lenihan said the state was leery of scaring markets by defaulting on Anglo’s senior debt, which takes priority over other creditors for being repaid in event of a bankruptcy.
“We have to get bondholders from overseas to fund the Irish state, and to fund the substantial deficit,” he said. “You can’t go to your bank manager and say, ‘I want to default,’ and at the same time, ‘I want more loans.’ If that’s the underlying message coming out of Ireland, we’re not going to flourish as a country.”
Compounding the government’s difficulties is the fact that the economy continues to stagnate, making it all the more difficult for the banks to collect on their loans.
Ireland’s economy is expected to shrink again this year, which will make it the only major European economy to experience three consecutive years of negative growth.
In fact, it is this struggle for the economy to recover that still concerns some analysts, who caution that the bill may well rise some more.
Mr. Lenihan, who is also suffering from pancreatic cancer, has become the public face of Ireland’s long battle to gain control of its public finances. On Thursday, he confirmed what many in Dublin had come to accept as a brutal reality: that the country’s next budget would have to include more spending cuts.
Until the government can demonstrate to investors that it can reduce its budget deficit, investors are likely to remain cautious about lending money to Ireland, a dangerous reality the government has accepted with its retreat from the bond market.
“We have spent two years cutting deficits and we still do not have things under control,” said Constantin Gurdgiev, a professor of finance at Trinity College in Dublin. “We already have a solvency crisis, now we are setting ourselves up for a liquidity crisis.”
