Expensive Bailout for Irish

Based on the articles from the November 28th, 2010 editions of  Reuters and the Financial Times, Ireland is set to receive a 85 billion euro ($110 billion) rescue package from the European Union.  As for the specific terms, around 10 billion euros of the funds will be used to recapitalize their financial system and bring them up to core Tier 1 capital requirements.  Tier 1 capital is what the industry uses to measure liquidity and their ability to absorb bad loans.  An additional 25 billion euros will be available to cover any future deterioration.  As for the remaining amount, they will be used by the Irish government in meeting their budgetary requirements.  Overall, this is a costly bailout for the Irish and will require significant sacrifice from its citizens.

We must consider that the Irish government has already made a commitment to resolving their economic crisis where their solutions are geared toward more efficiency and less equity.  They have committed a combination of spending cuts (67%) and tax increases (33%) totaling 15 billion euros over a four year period.  Due to concerns about losing direct foreign investment, they decided to maintain their corporate tax rate from 12.5%, which is substantially lower than the U.S. corporate tax rate of 35%.  However to accomplish this, they had to resort to cuts in welfare and lowering the pay of public sector workers.  In addition, the minimum wage will be slashed by 12% and tax code changes that are more onerous to the working poor.  By lowering the bar where income tax rate kicks in, more lower income individuals will see their tax liability rise.  These proposals are considered more efficient because it will minimize the loss of foreign capital that can boost economic growth, but will lower equity because the burden will of the shortfall will be felt more by the poor than the wealthy.

Then there are concerns about the high interest rate for obtaining the rescue funds.  As reported in the November 28th, 2010 Irish Times, the average interest rate will be 5.8% which exceeds the average interest rate for 5.2%.  This is a bitter pill for Ireland to swallow because they have exhibited a stronger political will than Greece, their southern brethren.  Under these terms, they will no longer get access to short-term funds from the European Central Bank, which are much cheaper.

In order to save Ireland's financial industry, further commitments from the Irish and the International Monetary Fund will also be needed with concerns that this contagion can spread.  The Irish government has agreed to commit 17.5 billion euros, while the International Monetary Fund, where the U.S. is the largest stakeholder, will extend 22.5 billion euros. 

There is concern of moral hazard where poor business practices are rewarded, but for now the global community does not want to risk the ramifications of any European country going bankrupt.  Greece started the trend with their 110 billion euro bailout in May 2010.  At the time, there was concerned that it would not stop there and it looks like it could go beyond Ireland.  Both Portugal and Spain are encountering similar problems, so it will be interesting to see if Europe can contain this burgeoning crisis.  Some argue that countries should be allowed to fail, but that ignores the significant financial interests present in the U.S., the rest of Europe, and throughout the world.  If any of the European countries did go bankrupt, then banks with European interests across the world would take massive losses.  This is problematic because global financing would be disrupted and that could lead to a severe credit crunch.  Its impact could be felt globally with the end result being further economic decline and higher unemployment.