Irish Eyes Are Crying, Part 6

It's all over but the shouting as Irish banks are expected to agree to a roughly $100 million bailout as bond spreads are crushing the country's ability to borrow.

European Union and International Monetary Fund experts will start scanning the books of Ireland’s debt-laden banks tomorrow in Dublin in a prelude to a possible aid package to stem Europe’s widening fiscal crisis.

Finance chiefs from the 16-country euro area said the joint assessment will determine whether Ireland can patch up the banking system on its own or needs to fall back on the EU-IMF 750 billion-euro ($1 trillion) rescue fund.

“If banking problems are too big for this small country to manage, Europe has made it clear they’ll help,” Irish Finance Minister Brian Lenihan told state broadcaster RTE today as meetings of European finance ministers wrapped up in Brussels.

As Europe struggled to present a united front to maintain its fiscal credibility, Britain said it would back support for Ireland, abandoning a hands-off policy toward the euro region to prevent Irish bank woes from spilling over into the U.K. market.

In a blow to Ireland, LCH Clearnet Ltd. raised the margin requirement for Irish bond trading to 30 percent of net positions, making it more expensive to buy Irish securities.

Irish bonds slipped for a second day, pushing the 10-year yield up 5 basis points to 8.51 percent. The extra yield over German bunds rose 6 basis points to 567 basis points. The spread, a measure of the risk of investing in Ireland, peaked at 646 basis points on Nov. 11.

The Dublin consultations with the ECB, European Commission and IMF will “see if the state is able to cover the needs of the banking sector,” Belgian Finance Minister Didier Reynders told reporters today. “If that’s not the case, there will probably have to be a European intervention.” 

Translation:  Ireland's going to have to take its medicine or the rest of the Eurozone is going to get very, very sick very, very quickly.   The bigger issue is that Ireland's massive austerity package failed across the board.

The country has stopped spending beyond its means, recently bringing its trade account into balance. A double-digit contraction since the 2008 financial meltdown has boosted business competitiveness. The government has slashed spending and socked away enough that it won't need to borrow in the markets till the spring of 2011.

And yet, what does Ireland have to show for it? Even after two years' worth of sacrifices to the financial markets, the long-feared confrontation with bond investors is at hand. The yield on Irish bonds recently jumped 13 consecutive trading days, bringing them near a back-breaking 8%.

Meanwhile, wages have been falling and unemployment has tripled to 13%. So while there is obviously much to be said for putting your national finances in order, in no sense is austerity the silver bullet it has often been sold as.

The only way to fix financial crisis problems like this is to tackle the problems head on and go after the banks, period.  Ireland should serve as a massive warning to austerity hawks that cutting your spending without dealing with the core problem of a broken banking system only leads to disaster.