Ireland's guarantee of banks is twice country's GNP

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, September 30, 2008

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3111122...

Ireland has launched a full-scale rescue of its financial system, issuing a state guarantee worth E400 billionn (L316 billion) to cover the key liabilities of its biggest banks and mortgage lenders.

It is the most dramatic and comprehensive bank bailout in Europe since the Scandinavian rescues of the early 1990s and may serve as a model for Britain and other countries that so far have been muddling through from one mishap to another with a mish-mash of ad-hoc policies.

The state guarantee exceeds 200 percent of Irish GDP, marking a new phase in the escalation of the crisis.

The move came as Standard & Poor's cut Iceland's sovereign credit rating from AA- to A+ following its nationalisation of Glitnir Bank. It is a warning that the cascade of bank bailouts on both sides of the Atlantic could start to undermine the creditworthiness of Western states.

S&P warned that the tiny Nordic island is now saddled with liabilities that dwarf its economy.

The euro suffered the sharpest drop since the launch of the currency, dropping almost 3 percent at one stage to $1.40 against the dollar in a day of high drama across Europe.

Belgium, France, and Luxembourg stepped in to rescue Dexia, the world's biggest lender to local authorities. The trio agreed to inject E6.4 billion in fresh capital after the share priced crashed on Monday. Dexia's top management stepped down.

"We must have total confidence in the safety of the French banking system: there is absolutely no reason to panic," said Christian Noyer, head of the Banque de France.

"The credit crisis is working its way up the food chain," said Chris Whalen, head of Institutional Risk Analytics.

"Now states that sponsored the idiocy of the credit bubble are being challenged themselves. Unfortunately this could lead to global debt deflation. We are seeing a shrinkage of bank capital and this will cause a depression unless we stop it," he said.

The Irish measures amounts to a state rescue of Allied Irish Bank, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, and Irish Nationwide, which all suffered a frightening share slide on Monday.

"We can't bail out a particular bank; that wouldn't be right," said Brian Lenihan, the Irish finance minister.

"What we have decided to do is give a general guarantee that the banks can lend in security and safety," he said.

RBC Capital Markets said it was unclear whether wholesale support for Irish banks is legal under EU state aid rules.

"This may be one Guinness too many for the EU Commission. The action may affect trade between EU member states and raise the ire of other governments," it said.

The EU Competition watchdog said it was in "urgent" consultations with Dublin.

The Irish banks have been bleeding money as the property bust sets off a chain of defaults. House prices have fallen for 18 months, and are now down 13 percent from their peak. Construction reached 21 percent of gross domestic product at the height of the bubble.

Under EMU membership the Irish authorities have been unable to cut interest rates to cushion the hard-landing. The European Central Bank raised rates in July to 4.25 percent. With Euribor now at record levels, the borrowing cost for Irish homeowners on floating rates (55pc of the total) has risen by 1.5 percentage points since the credit crunch began.

Ireland is now the first eurozone state in official recession. Unemployment has risen from 5 to 6.1 percent since January.

Moritz Kraemer, head of European sovereign ratings at S&P, said there is no immediate threat to Ireland's AAA rating. The country has tiny national debt (25 percent of GDP) and may not have to commit state funds for the rescue plan to restore confidence.

"If it all goes terrible wrong in the property market, there could be significant losses for the treasury given the size of the Irish banking system. This could hit the sovereign rating," he said.

It is another matter for Iceland, where the three biggest banks have ammassed liabilities equal to 800 percent of the country's GDP in a breackneck expansion across Europe.

S&P said the Glitnir nationalisation had alone cost 5.9 percent of GDP, but the taxpayer burden could reach well beyond that figure.

"The Icelandic banks are super-sized compared to the Icelandic budget. If there is a systemic crisis it could be very hard for the authorities to stop it. Moreover, the banks have used aggressive leverage, so their funding base is volatile," he said.

The euro suffered the sharpest drop since the launch of the currency, dropping almost 3pc at one stage to $1.40 against the dollar in a day of high drama across Europe.

Mr Whalen, who advises the Icelandic authorities, said the country would muddle through.

"Iceland has an open economy, so it has been easy for the hedge funds to come in and rape the currency. But the country is really like a giant private equity fund. Its banks buy real things so its liabilities are matched by assets. I am not really worried," he said.

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