Ireland has succumbed to the inevitable.
In agreeing to a bail-out, Ireland has become the second eurozone domino to topple in the space of seven months.
We don’t yet know the exact details of the bail-out. They’re still being hammered out. And for now, it looks as though markets have got their risk appetite back. Commodities are up and Asian markets closed higher this morning.
But we saw the same reaction after Greece. And just a few months later, we’re back with another bail-out. How long before the next domino topples?
Why Ireland needs the money
The Irish government is set to take an €80-€90bn bail-out from the eurozone, plus Britain and Sweden. The full details of the deal aren’t available yet and probably won’t be until the end of the month.
So why does Ireland need the money? Unlike Greece, Ireland’s main problem isn’t profligate public spending. Ireland’s problem is its banking sector.
In terms of borrowing money, the country itself didn’t need to go back to the bond markets until 2011. Unfortunately, you couldn’t say the same for the banks. They’ve been propped up by loans from the European Central Bank (ECB) and also from the Irish central bank.
But as concerns have grown over the state of the economy, there’s been evidence of a slow-moving bank run (or ‘bank walk’, as some wags have put it) on Irish institutions. For example, an estimate by Ciaran Callaghan of Dublin-based NCB Stockbrokers, suggests that Bank of Ireland lost €10bn in deposits between late August and early September.
For all the support given by the ECB, depositors have clearly been becoming increasingly nervous that – to put it simply – Irish banks would just run out of money. The Irish government promised that it would stand behind the banks. But of course, everyone’s realised by now that this is a hollow promise – the Irish state can’t afford to bail out its entire banking sector.
Why does the rest of Europe care?
Well it’s not just about European solidarity. As Wolfgang Munchau points out in the FT, Britain and Germany are Ireland’s two biggest creditors. The country owes our banks €149bn and the Germans €139bn. So if the Irish banking system had gone bust, then we’d potentially have been back on the hook for more bail-outs of our own banks.
So that was one reason why a rescue package was needed sooner rather than later. The other reason was the threat of fear spreading to other countries. Portugal is already under the spotlight. If it was just Portugal, then it wouldn’t be so bad – the EU has enough money set aside already to help Portugal out. But if Spain’s banking system looked like blowing up, it’d be a different story.
The point of the loan is to give Ireland breathing space to sort out its banking system and reduce its public deficit. Taxes are going to have to be raised, and spending slashed even further. The banks will also be stress-tested again apparently – let’s hope the tests are bit more stressful than the last lot of eurozone tests.
What Ireland’s bail-out means for markets
We’ll find out more this week about Ireland’s plans for both its economy and for its banking sector. But for now, what does all this mean for markets? This morning, markets were largely rallying. Yet this seems a tad short-sighted. As the FT says, the Irish rescue has “put paid to Europe’s hopes that a ‘shock-and-awe’ €750bn backstop, arranged after a bail-out of Greece in May, would impress financial markets so much that it would never need to be used”.
Given that the first bail-out didn’t do the job, there’s no reason why this one will stop the rot either. And pundits are already casting about for the next domino to topple. The obvious candidate is Portugal. But it’s far from being the only one.
In the FT, John Dizard casts his gaze back to Greece. He notes that saving Ireland should prevent – for now – a similar run on the Spanish banking system. So instead of worrying about the banks, “this coming week, euro-area finance will turn back to sovereign insolvency, which means, for the moment, Greece”.
One condition for the Greek bail-out package earlier this year was that Greece should meet targets on its tax take and on spending cuts. They apparently haven’t met them, but the next tranche of bail-out money is going to be released anyway. But Dizard reckons it’s only a matter of time before the country admits it will have to restructure its debt (in other words, investors in Greek debt will have to take a hit to their holdings).
In short, this isn’t over. The future of the euro still hangs in the balance. And until countries start coming clean about the state of their banking systems in particular, we’re likely to see more emergency bail-outs and fraught weekends of negotiation in the future. We wouldn’t bet on any respite for the single currency lasting for long. I suspect the next ‘crisis’ will arrive sooner rather than later.
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