Ireland Seeks Rescue as EU Struggles to Stem Contagion (Update1)

By Joe Brennan and Dara Doyle
Nov. 22 (Bloomberg) -- Ireland sought international aid, becoming the second euro country to need a rescue as the cost of saving its banks threatened a rerun of the Greek debt crisis that destabilized the currency. The euro and European stocks advanced.
Ireland will channel some of the money from the European Union and International Monetary Fund to lenders through a “contingent” capital fund, Irish Finance Minister Brian Lenihan told reporters late yesterday. The rest of the package, which Goldman Sachs Group Inc. estimates may total 95 billion euros ($130 billion), would help Ireland avoid selling bonds.
“The banks were too big a problem for the country,”
Lenihan said in Dublin. “The key issue all the time for the government is to ensure that we do not have a collapse of the banking sector.”
The aid, which Irish officials said as recently as Nov. 15 they didn’t need, marks the latest blow to an economy that more than doubled in the decade ending in 2006. The bursting of the real-estate bubble in 2008 plunged the country into a recession and brought its banks close to collapse. With Irish bond yields near a record, policy makers are trying to keep the crisis from engulfing Portugal and Spain, the fourth-largest euro economy.
“Speculative actions against Portugal and Spain are not justified, though it can’t be excluded,” Jean-Claude Juncker, who leads the group of euro-area finance ministers, said today on RTL Luxembourg radio.

Euro Gains

The euro rose 0.5 percent to $1.3740 at 8:40 a.m. in London. Irish 10-year notes rose, sending the yield down 12 basis points to 7.99 percent. The Euro Stoxx 50 Index gained 0.7 percent to 2864.67.
“Ireland had no choice,” said Nicholas Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for money managers. “The market will still be waiting for the details of the assistance and the conditionality, but there should be a relief rally.”
The U.K. and Sweden may contribute bilateral loans, the EU said in a statement. Lenihan declined to say how big the package will be, saying that it will be less than 100 billion euros.
Goldman Sachs Chief European Economist Erik Nielsen said yesterday the government needs 65 billion euros to fund itself for the next three years and 30 billion euros for the banks.
Nielsen said investors will be looking to the final agreement for details on how creditors will be treated in any burden sharing among bank stakeholders.

Bank Overhaul

Talks will focus on the government’s deficit cutting plans and restructuring the banking system, the EU said in a statement. Irish Prime Minister Brian Cowen, who spoke at the same press briefing as Lenihan, said the banks will be stress tested. Ireland nationalized Anglo Irish Bank Corp. in 2009 and is preparing to take a majority stake in Allied Irish Banks Plc, the second-largest bank.
Lenihan and Cowen appeared minutes after finance chiefs issued their statement endorsing an aid request to calm markets.
Allied Irish emphasized the fragility of the system on Nov. 19, reporting a 17 percent decline in deposits this year.
“In the short term, it will stabilize the situation, there’s no doubt about that,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, who estimates a package of between 80 billion euros and 100 billion euros. “But as we’ve seen in the case of Greece, uncertainty will remain.”

Elections

Cowen plans to announce the government’s four-year budget plan this week and said an agreement with the EU and the IMF will come “in the next few weeks.” Cowen also faces an election in Donegal in northwest Ireland on Nov. 25 to fill a vacant parliamentary seat. The vote threatens to erode Cowen’s majority. He has the support of 82 lawmakers, including independents, compared with 79 for the combined opposition.
The bailout follows two years of budget cuts that failed to restore market confidence as the cost of shoring up the financial industry soared. The head of the Organization for Economic Cooperation and Development, Angel Gurria, urged officials to provide as large a bailout fund as possible.
Lenihan cancelled bond auctions for October and November and announced 6 billion euros of austerity measures for 2011 on Nov. 4 in a bid to restore investor confidence. Those efforts failed after German Chancellor Angela Merkel triggered an investor exodus by saying bondholders should foot some of the bill in any future bailout.

Bond Spreads

The risk premium on Ireland’s 10-year debt over German bunds, Europe’s benchmark, widened to a record 652 basis points on Nov. 11, with the yield reaching a record 9.1 percent. In 2007, it cost Ireland less than Germany to borrow. Its 10-year spread then fell to as low as 77 basis points less than bunds.
The ISEQ stock index has plunged 70 percent from its record in 2007.
Ireland will draw on the 750-billion-euro fund set up by the EU and IMF in May as part of the Greek bailout to prevent euro members woes from undermining the currency shared by 16 countries.
Europe’s sovereign debt crisis erupted after Greek Premier George Papandreou said the budget deficit was twice as big as the prior administration had disclosed. The EU and IMF approved a 110 billion-euro aid package on May 2 in exchange for cuts in public-sector wages and pensions and increased taxes on fuel, alcohol and cigarettes.
Irish officials initially resisted pressure from the EU to take any aid, saying they were fully funded until the middle of 2011. European leaders sought to head off contagion from Ireland and reduce pressure on the European Central Bank to prop up the country’s lenders by providing them with unlimited liquidity.

Not the ‘Bogeyman’

Cowen defended his reversal on the need for aid when speaking to reporters late yesterday. “I don’t accept I’m the bogeyman,” he said. “Now circumstances have changed, we’ve changed our policies.”
Yields on bonds of Spain and Portugal have jumped amid concern that fallout from Ireland would spread. The extra yield that investors demand to hold Portuguese 10-year bonds instead of German bunds climbed to a record 484 basis points on Nov. 11.
“It probably won’t halt contagion. The sovereign crisis isn’t yet over,” said Sylvain Broyer, chief euro-region economist at Natixis in Frankfurt. “Ireland is in the middle of a difficult crisis.”
It went disastrously wrong for Ireland following the 2008 demise of Lehman Brothers Holdings Inc., which turned a slowdown in the property market into an implosion that engulfed the economy.

Ireland’s Advance

Ireland was one of the poorest countries in Europe when it joined the EU in 1973 along with Britain. Even with European subsidies, unemployment in the mid-1980s averaged 16 percent.
In the 1990s, lured by a 12.5 percent corporate tax, companies such as Pfizer Inc. and Microsoft Corp. helped Ireland export its way into becoming the “Celtic Tiger.” The jobless rate sank to 3.9 percent by 2001. In the decade through 2006, Ireland grew at an average annual rate of about 7 percent, the fastest among euro countries.
That expansion, together with easy credit, fanned a real estate bubble. Home prices almost quadrupled in the decade through 2007.
Irish Central Bank Governor Patrick Honohan said total loan losses at the country’s lenders, including foreign-owned banks, total at least 85 billion euros, about half of GDP. Residential property prices have dropped 36 percent since 2006, based on an index compiled by Irish Life & Permanent Plc and the Economic & Social Research Institute in Dublin, requiring the bank rescue that is emptying government coffers.
“The Irish banking system,” Lenihan said in a Sept. 30 Bloomberg Television interview, “is at rock bottom.”