The government of Ireland sought a European Union-International Monetary Fund bailout over the weekend, finally succumbing to pressure from its fellow Eurozone members and panicked financial markets. That makes Ireland the second of the Eurozone’s 16 members to require a rescue, after Greece got a $150 billion package in May. Ireland’s will likely be smaller – perhaps $110 billion over three years — though the final details are still being negotiated. Olli Rehn, the EU commissioner for monetary affairs, said the bailout of Ireland is “a critical step forward” to “safeguard financial stability in Europe.”
The Irish bailout will bring to a close weeks of rabid speculation about Ireland’s fate that plagued financial markets throughout the world. But is the Irish rescue finally the end of the chaotic instability the Eurozone has experienced for more than a year? Will investor confidence be restored over the zone’s future? Probably not, in my opinion. As has been the case throughout the euro crisis, Europe’s leaders are dealing with only one part of a bigger problem, and only when their backs are against the wall.
The Ireland crisis followed a similar pattern to the Greek crisis earlier this year. For weeks, Ireland’s ministers and their counterparts across Europe vowed that the country could go it alone and fix its own financial woes without EU aid, hoping that the Irish economy could muddle through until sentiment in financial markets improved. But as with Greece, investors didn’t believe them. In Greece’s case, the concern was the miserable state of the government’s finances; in Ireland’s, it’s the burden of a floundering banking sector brought low by a property bust. But in both cases, the numbers were just too ugly. In September, the Irish government said its bank rescue plan would push the budget deficit up to a staggering 32% of GDP this year and balloon its government debt to 99% of GDP. So, as was the case with Greece, nervous investors kept hiking up the spread between Irish government bonds and benchmark German bonds to record levels, a sign that bondholders saw Ireland’s debt as increasingly risky to hold. Finally, Ireland and the EU bowed to the inevitable – a bailout. “A small sovereign like Ireland faced with an outsized problem that we have in our banking sector, cannot on its own address all those problems,” Irish Finance Minister Brian Lenihan admitted.
Just as the Greek bailout failed to stem the euro crisis, I believe the Irish bailout will fail as well. That’s because all of the underlying issues will remain in place. Sure, this time around, the EU has funds already committed to help Ireland – the $1 trillion rescue fund announced in May, which didn’t exist during the Greek meltdown. But the availability of bailout money won’t resolve the uncertainties inherent in the very nature of the EU’s bailout scheme.
First, the success of the bailout will depend on the ability of Ireland’s government to impose incredibly severe budget cuts, demanded by its Eurozone pals in return for the rescue funds. In other words, the Irish people will have to absorb years of economic pain to protect bondholders in Germany, the UK and France. As in the situation in Greece, my guess is that investors will continue to hold doubts as to whether that formula is viable. Concerns will persist over whether Ireland can politically or economically impose such austerity measures while the economy is contracting. That may keep investors nervous, as they are with Greece, that a restructuring of debt might still be waiting in the wings, an outcome that would force a haircut on bondholders.
Second, the bailout of Ireland, as with Greece, does nothing to help the economy out of its crisis, aside from preventing an outright default. The rescue scheme ignores the crucial ingredient of growth – without which Ireland will struggle to close its budget gap, resolve its banking crisis and pay off its debts. In fact, by forcing vicious austerity measures onto the Irish economy, the bailout will only make that turnaround more difficult.
To put it simply, the entire bailout mechanism forged by the EU leaves too many questions unanswered, and thus will keep financial markets jittery. That doesn’t bode well for the fates of the Eurozone’s other weak members, especially Portugal and Spain, whose bonds have also been punished recently. Spain’s finance minister already came out to claim Spain is not Ireland. That foreshadows the possibility that events with Portugal and Spain could follow the same course we’ve seen with Greece and Ireland – a combination of denial, delay and investor doubt that causes a self-fulfilling deterioration in financial markets.
I’m not saying that Spain and Portugal will inevitably suffer the same fate as Greece and Ireland. Each economy is different, and hopefully investors will realize that. And there is a chance that Europe, by showing that it is committed to employing its $1 trillion fund, can stop the contagion at Ireland’s shores. Perhaps officials in Spain and Portugal can implement the reforms to keep investors appeased.
But the case of Ireland shows that even reform might not be enough to hold off a crisis once markets get nervous. The government of Ireland has been universally praised for its upright handling of its banking crisis and budgetary woes, but that wasn’t enough to save them.
Even more, the ad hoc way in which Europe is handling its debt crisis – acting only when pushed to the precipice, with a program in which the stronger Eurozone members impose pain on the weaker – isn’t tackling the roots of that crisis. That’s why all of the previous steps taken by the EU– the Greek bailout, the trillion dollar fund, EU reform proposals – haven’t stemmed the crisis. What the Eurozone requires is a proactive effort to engage its problems in a more comprehensive way, helping the weaker members to resolve their debts and return to healthy growth, not just saddling them with further debt to prevent losses at European banks. Unfortunately, based on the evidence of the past year, Europe’s leaders are going to continue to muddle through, hoping they don’t have to do more than they’ve already done. I fear that won’t be enough.