On the heels of Greece’s financial meltdown in May and a European Union backed bailout, the Celtic Tiger, otherwise known as Ireland, finds itself in a similar predicament.
The latest financial crash and subsequent bailout threatens to increase the likelihood of a domino effect throughout most of the Euro block countries including Portugal and Spain. Ireland’s banking crisis hit the news approximately two weeks ago when the country began slipping deeper and deeper into debt as a result of rescuing its banks, which were overly exposed after the Irish housing bubble burst.
Ireland’s financial regulators acted incompetently and at the first sign of trouble. The government issued a blanket guarantee for all its banks’ debts, which means that the taxpayers have to bear the losses on bets made by Irish banks.
This will cause the budget deficit to rise to 32% of gross domestic product this year. Housing prices continue to fall, and unemployment continues to rise. The financial markets believe that Ireland might eventually be unable to pay its debts, and worries abound that Ireland’s crisis could lead to another loss of confidence on the euro.
As a result, investors began to rush out of Irish government debt. The spread between ten year bond yields in Ireland and Germany (German Bunds) continued to widen as shown below.
To compound the problem, Germany has insisted that plans for a sovereign debt default should be part of any future Eurozone rescue scheme.
Ireland made it clear that the treasury had enough cash (20 billion Euro) to get the country safely into next year and that it saw assistance from outside as a loss of sovereignty because it would come with tough budgetary conditions. Nevertheless, as Ireland continued to be priced out of the bond markets, the country had no choice but to accept help from other European member nations.
Ireland yielded to the pressure and accepted what may amount to 85 billion euros ($115 billion US) from the European Union and the IMF to assist the country in weathering its banking crisis.
The Irish Prime Minister, Brian Cowen, who soon faces reelection and must pass the budget in early December (which includes 6 billion euros in spending cuts), said his country will take 10 billion euro immediately to boost the capital reserves of its state-backed banks and another 25 billion euros will remain in reserve, earmarked for the banks. The rest of the loans will be used to cover Ireland’s deficits for the coming four years. Additionally, certain austerity measures were imposed by the European Union chiefs, including a reduction in Ireland’s annual deficits to 3 percent of GDP, the Eurozone limit, by 2015.
Within 24 hours of the announcement, the spreads of Irish, Spanish, Portuguese and German debt over German bonds were even wider than before the deal was announced. In fact, the spread on Spanish bond’s reached its highest since the euro’s launch in 1999.
European nations are worried that that the tension over Ireland’s stability is making borrowing more expensive for countries like Portugal and Spain, inching them closer to default. Portugal, which comprises 1.8% of the Eurozone economy is not as large a concern as Spain, which makes up 11.7%.
Spain seems poised to remain relatively unaffected, for now, as its banking system does not appear as broken, and national debt as a percentage of GDP at 53% is 21 points below the European Union average. However, just as Greece and Ireland had their own unique problems, so, too, does Spain. Spain’s finance minister insists that the country is implementing the necessary structural reforms to stay ahead of the crisis.
The Germans, though, will make another bailout, if needed, difficult; German voters have expressed a strong distaste of euro-backed bailouts.
Although the financial crisis looms on the horizon for the Iberian countries such as Spain and Portugal, they will continue to do what is necessary to insulate their countries from the spread. Nevertheless, some would contend that the euro as a currency is possibly at stake.