Crisis in Ireland tests eurozone vision of common currency, common interests

To be sure, the economic woes of Ireland and Greece as well as that of debt-strapped Portugal aren’t identical. Irish banks are blamed for engaging in risky lending during the real estate boom. Banks there are holding about $90 billion in bad loans. Greece reportedly cooked its books for years. Portugal has consumer, public, and corporate debt.

But bond markets don’t care about the unique causes of a country’s fiscal woes, and investor unease can rattle the entire eurozone. Europe’s financial ministers worry that Ire­land’s troubles may spread to Portugal and even Spain, the fourth-largest economy in the eurozone. A fallen Spain, many observers say, would make the current crisis seem tame.

EU and International Monetary Fund officials are now in Dublin examining Irish bank books and discovering that in recent weeks at least six banks have had difficulties, including loan-to-deposit ratios of more than 160 percent, according to The New York Times.

Philippe Waechter, chief economist for Nat­ixis Asset Manage­ment in Paris, says that ways must be found to keep individual economies from collapse in order to protect the euro. “Investor behavior must change, and now is better than later, when restructuring could be more painful, including for bondholders, he says.”

'Moral hazard'

The broader concern stems from two issues: Much of Ireland’s debt is held by governments and large banks in the eurozone. An Irish default could trigger concerns about the financial stability of those institutions. A bailout for investors who provided much of the cash that fueled Ireland’s real estate bubble could create what economists call a “moral hazard” – a perception among debt investors that they can roll the dice within the eurozone without much risk, because the European central bank or the stronger economies will, in the end, ensure that they are repaid.

If the perceived risk behind investments is removed, more money may be pumped into bad investments, all but assuring future bailouts or more calamitous defaults.

While bad debt in Ireland and the fiscal woes of Greece have set off alarms over the euro, Iain Begg at the London School of Economics says the sheer size of the $1 trillion EU safety net should stave off a larger crisis. “I’m reasonably optimistic. The EU is an institution that will walk to the precipice, look down, and say ‘We’re not going to jump.’ ”

Irish Prime Minister Brian Cowen – who announced Monday that elections could be held early next year – had resisted EU pressure to take any assistance, possibly out of pride and concern about the conditions that might be attached to the aid. Ireland’s 12.5 percent corporate tax rate (the third lowest in Europe, after Bulgaria and Cyprus), a key lure for foreign investors, is a prime EU target.

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