Many of Ireland’s current problems date back to 2008, when the Dublin government became the first in Europe to recapitalise its banks.

Much of Ireland’s growth had been built on the property market, which collapsed at the start of the global downturn.

Ireland’s banks had given huge loans to property developers and, as house values fell, the bad debts in the banks increased.It meant that the Irish government had to act to save the banks, but in so doing, it transferred the problem from the banks to the entire state.

The Anglo-Irish Bank was nationalised in January 2009, and two other banks, Allied Irish and Bank of Ireland, were both bailed out.

Stress test

In July 2010, two banks based in Ireland passed stress tests carried out by the Committee of European Banking Supervisors to verify their health and stability in the event that Dublin suffered sovereign loans difficulties.

Bank of Ireland and Allied Irish Banks (AIB) were two of 91 banks across the EU that passed the checks. Both banks had already passed the stricter tests carried out by Ireland’s own financial regulator. But Allied Irish was named by the committee as among 17 that were close to failing the test.

At the time of the results, some commentators complained that the tests were insufficiently rigorous, and would not give the EU economy the reassurance it needed. They said tests did not examine what would happen in the event of a sovereign default, and measured only how banks would react to a drop in the market value of government debt.

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Where will it all end?

Shahin Vallée, visiting fellow, Bruegel:
“I’m worried financial markets have concluded it will be difficult for Portugal to avoid going into the European Financial Stability Facility (EFSF). Whether it’s based on fundamentals doesn’t matter. Portugal was already impacted…The question is whether Spain is left untouched.

The broad consensus in financial markets is that both Ireland and Portugal will be under financial assistance soon. The longer it takes to put Portugal under the financial umbrella, the longer questions are being asked about Spain. Markets are not looking at sources of imbalances. The earlier the EU sends the message it will cover Portugal, the better.

A joint programme for Ireland and Portugal would have helped a lot to mitigate financial stress…Ireland should have been under a programme three weeks ago. Ireland waited until its financial sector saw major outflows before it decided [to accept assistance]. That’s what pulled the trigger. If it had been done pre-emptively we could have avoided the sort of stress Portugal is under now.”

Marco Annunziata, chief economist, Unicredit:
“In both Spain and Portugal there is room for more effort on structural reforms. Part of what markets are worried about is if they can produce enough growth. To eliminate risk of contagion in Spain, any measures to strengthen or consolidate the banking system [would help]. It’s clear Spain is vulnerable to contagion. Investors realise Spain has stronger fundamentals [than Portugal] but the greatest area of uncertainty is the banking sector.

I thought Ireland had a chance of avoiding the EFSF-IMF scenario. If Germany hadn’t pushed the discussion of restructuring they might have avoided [it]. There’s enough money [in the EFSF] to deal with Ireland and Portugal. It’s not clear at all if it would be enough if Spain got into trouble. That makes it all the more important to do everything possible to avoid it.”

Otmar Issing, former chief economist of the European Central Bank:
“It’s a dangerous situation. It’s a situation which hasn’t come unexpected. Imbalances built up over a long time. This mustn’t happen again. We need surveillance and sanctioning mechanism at an early stage.

I would be satisfied with the Stability and Growth Pact being applied strictly and having a future mechanism which doesn’t create moral hazard problems. We have to look at divergences in unit labour costs and prevent bubbles in housing markets like you have had in Spain and Ireland.

[On asking bondholders to share in the cost of debt restructuring]

In principle, it’s obvious. Discussing it now at the time of market turmoil is a different issue.

Cinzia Alcidi, research fellow, Centre of European Policy Studies:
“The problem is basically we have the EFSF, we know Ireland will tap into it, but we don’t know what size of support Ireland will receive…

When the EFSF was set up everyone thought that the sum of money was so big it was enough. If you look at the details, the amount of money is smaller than the €440 billion, which is 120% of the available amount. This amount was not chosen by chance. It was to get the AAA status [from the ratings agencies]. It accounted for the possibility that if Greece, Ireland, Portugal and Spain needed help, they couldn’t bring guarantees and money into the fund. There’s a problem of uncertainty. We don’t know the size [of the support needed]. In principle, up to Portugal it’s fine. When Spain comes in, the picture is blurred; it’s a large country with a huge and complex financial system.”

Restructuring costs

In September the Irish government revealed that the cost of restructuring AIB would be €29.3 billion.

At that time Brian Lenihan, Ireland’s finance minister, said: “Greater certainty on the final costs of repairing the banking system in Ireland will provide reassurance to investors on the capacity of the Irish state to absorb these costs.” He described the level of state support needed for AIB as “manageable”, and said it could “be accommodated in the government’s fiscal plans in the coming years”.