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State will be left to pick up pieces if latest bailout isn't enough

The €24bn bank bailout announced last Wednesday is the second multi-billion bailout in about four months. It follows a string of bank bailouts over the last two years -- which have cost the State a staggering €46bn so far.

That €24bn is the most the Central Bank believes will have to be poured into the Irish banks over the next few years. It brings the total bill for rescuing the banks to €70bn -- almost as much as it cost to build the International Space Station. Yet experts believe the €24bn will not be enough to save the Irish banks -- and that it is only a matter of time before another bailout comes knocking on our door.

"This is the fifth strand of recapitalisations, and at each stage we're been assured that the bailout is the final figure," said Ray Kinsella, a professor with the UCD Quinn School of Business. "We now have about €70bn of bank debt, as well as the €30bn of loans gone into our State bad bank, Nama. A banking system can only be as healthy as the economy it services. Our economy has consistently got worse than official projections.

"And our banks have gone from having a nasty cold, to going into intensive care, to exhibiting every indication of rigor mortis."

Jim Power, chief economist with Friends First, said he would be "surprised" if the €24bn turns out to be the final bailout bill. "The announcement last Wednesday does not represent a line in the sand -- and it won't encourage depositors and investors to return to the banks," said Mr Power. "It's one thing to create solvency in the banks -- it's another to get credit flowing again. It could cost another €50bn, rather than another €24bn, to get the banking system back to a place where credit is flowing again."

Mr Power said that Ireland is already very near the worst- case scenario envisaged in the Central Bank's latest stress tests. That scenario includes a 1.6 per cent drop in our economic growth next year -- and unemployment peaking at 15.8 per cent. Our economic growth already slumped by one per cent last year -- five times worse than the Central Bank had expected. Some believe unemployment could go well beyond the worst-case scenario envisaged by the Central Bank. "The assumption that unemployment will peak at 15.8 per cent doesn't seem as stressful as it could be," said Hank Calenti, head of bank credit research with Societe Generale.

The Central Bank believes that the total losses of the Irish banks -- which include AIB, Bank of Ireland, EBS and Irish Life & Permanent (IL&P) -- will come to €27.7bn over the next three years.

"This estimate is based on assumptions such as worst-case scenarios for unemployment and so on," said Mr Calenti. "The question is -- are these assumptions correct? There's no guarantee the loss projection is correct."

Under the Central Bank's plan, the four banks must offload about €70bn-worth of loans over the next three years. IL&P must almost halve its loan book -- from €37bn to €21.3bn -- by December 2013. AIB has to shave off about a fifth of its loan book; Bank of Ireland almost a third.

Justin Urquhart Stewart, director of Seven Investment Management, believes it will be "really difficult" for the banks to offload that amount of loans in three years.

"To do that, there will be a lot of good loans that you may have to sell -- but that you want to hold on to."

Mr Calenti warned that a big sell-off of loans over three years could have a negative impact on our economy.

"It could cause economic growth to be lower than expected -- and push losses on residential mortgages higher than assumed," he said.

If loan losses are higher than expected, it will be the Irish Government, rather than the banks, that will have to pick up the pieces. This adds another dangerous twist to the bank bailout tale.

"This [the €24bn bailout and restructuring of the banks] is the effective nationalisation of the Irish banking system," said Michael Symonds, credit analyst with Daiwa Capital Markets Europe. "The result of this is that solvency concerns will now decisively shift from the banks to the Irish State."

With the State now in the frame, another bank bailout could be the least of our worries -- it could be the State that needs a massive bailout.

"We currently have a national debt of €94.5bn -- and we are likely to have to borrow another €50bn to keep the country running," said Mr Power.

"This brings our national debt to about €145bn. Superimpose the €70bn that we could need to bail out our banks, and our sovereign debt comes to €220bn. It's not possible for the Irish economy to carry that amount of debt."

John McHale, professor of economics in NUI Galway, believes the €24bn bill is enough to save the Irish banks. However, he feels the new EU bailout fund, the European Stability Mechanism (ESM), could be the trigger for a State bailout.

"It's hard for banks to be considered credit-worthy if there isn't a credit-worthy state standing behind them," said Mr McHale.

"There won't be another bailout for the banks -- but the State is another issue. The big problem is that the ESM builds in burden sharing so bondholders could have to take a haircut under the ESM. No one will want to lend to Ireland in a few years' time because the ESM is designed to allow investors to shoulder losses. For that reason, it will be very hard for the Irish Government to raise money -- so the Irish State itself may need a bailout from Europe in a few years."

Investors clearly believe that Ireland cannot repay the €67.5bn loans agreed under last November's IMF-EU deal. The cost of insuring against the Irish Government going bust is sky high. "After the IMF came in, you would normally expect a sharp fall in the costs of insuring against a default -- but that hasn't happened," said Mr Kinsella.

"The market is still betting on a default. The markets are telling us that a default is probable over the next five years."

Mr Kinsella believes that a default by Ireland would trigger a break-up of the eurozone and lead to a two-tier Europe -- where a weaker common currency could be dished out to vulnerable debt-ridden countries like Ireland.

"If there is a default, the consequences won't stop in Ireland -- or in peripheral EU countries," said Mr Kinsella.

The €67.5bn IMF-EU bailout is made up of three loans -- €22.5bn from the IMF, and €45bn from two EU bailout funds and shared loans from Britain, Sweden and Denmark. Mr Kinsella believes that Europe should write off the EU portions of the debt.

"Europe has to accept that it is at least partly responsible for what has happened in Ireland, including the exacerbation of the Irish debt problem with the terms of its bailout deal," said Mr Kinsella. "In the interest of EU solidarity -- and to prevent the contagion that would arise from an Irish default, the EU should write off the EU portions of the EU-IMF debt."

The chances of Europe letting Ireland off a €67.5bn hook are, however, less than slim. Indeed, a reduction in the bailout interest rate would be a major coup given the opposition to such a move from German chancellor Angela Merkel and French President Nicolas Sarkozy.

How (and if) Ireland muddles out of its financial crisis remains to be seen. One thing financial experts are certain of, however, is that it will take a lot longer than three years -- the time-frame envisaged in the latest Central Bank plan -- for the Irish banks to get back on their feet.

"It will take a decade to restore confidence," said Mr Urquhart Stewart. "You're going to have to go through a five-year period of restructuring and another five years of restoring confidence."

Mr Calenti believes it could be another 20 years before the Irish banks repay all the state and EU aid. "The Nordic banking crisis happened in the early Nineties -- 20 years later, there is still some material government investment in those banks," said Mr Calenti.

Mr Kinsella believes it could take until 2020 to rebuild the Irish banks and economy.

We're in a for a long and painful wait.

Sunday Indo Business