BondSquawk

By Maulik Mody – Bondsquawk.com

November 22, 2010

As Ireland comes close to accepting financial aid, set up by the European Union and the International Monetary Fund, other concerns about the stressed Euro zone have started to surface. Analysts estimate that the rescue package will be close to 100 billion euro, which comprises of about 60 billion needed by the Irish government and 35 billion to support its banks. But two things that weigh on investor’s minds is whether this financial aid will help Ireland come out of its structural and political issues, and the possibility of the Ireland fiasco having a contagion effect on the other nations queued up.

Irish bond and CDS markets suggest that the bailout for Ireland was inevitable, but whether this will work is questionable. The finance minister said Irish banks became a threat to the entire euro zone by the amount of risk they took, and highlighted that they will be downsized and made to focus on consumers and businesses. Ireland also plans to perform stress tests on banks. Besides the financial crisis, investors are also concerned about the political climate of the nation as Green Party said it will pull out of Ireland’s Prime Minister’s coalition. Ireland is planning the government’s four year budget, which will chalk out plans to cut government deficit and restructure the banking system.

Plans to cut deficits and restructure debt will not prove as a solution that Ireland, and the euro zone in general, faces. Soon after the Greek banking system had started wobbling, a contagion effect was seen to affect other peripheral nations including Ireland and Portugal. Only a few months after Greece accepted the rescue aid, analysts increased the time that the country would need to pay back the funds to the IMF and also speculated another possible debt restructuring. This makes me wonder how Ireland will prove to be different and actually benefit from the financial aid.

Ireland’s banking system has shown that its three big banks had total liabilities that matched 200% of its GDP. The first step for Ireland and other peripheral nations that face similar problems would be to break down these banks to mid-sized banks that can be better regulated and managed. Portugal’s 10-Yr yield which is now close to 6.75% suggests that it might be next, but this may not be due to a crisis in the banking system. In Portugal’s case, debt problems have surfaced since its growth has been slow as opposed to others. This is due to the economy’s incompetency and poor management as compared to others. The slight relief however, would be that the cost of bailing out Portugal may be less than half the cost of bailing Ireland, or less than 50 billion euro.