The Irish Bank Bailout

Authorities in Europe are scrambling to put together a bailout for Ireland before financial markets open on Monday. However, the circumstances of this latest bailout are perhaps the most interesting - and eyebrow raising - of the many rescue schemes launched in recent years. Unlike the banks and Greece, Ireland does not actually need any money in the immediate future. The country has already borrowed all the money it will need until the middle of 2011. And unlike most other bailouts, the terms of this bailout will cause the Irish economy to contract because of spending cuts. It is also likely to damage the fiscal position of the government. So what is going on?

Ireland's banks are in trouble. And they need money soon. It is difficult to ascertain how much the banking sector needs to stay afloat, but news sources have been reporting numbers ranging from about 30 to 60 billion USD. Controversy, of course, abounds about the wisdom of bank bailouts. But the logic of supporting the banks in this instance appears especially weak. The standard argument in support of bank bailouts usually goes something like: credit is vital to keeping the economy moving; if banks fail, lending will grind to a virtual halt. In Ireland, this line of reasoning does not hold water. In order to keep the economy moving, the country is giving a bunch of money to banks. In order to bailout banks, taxes are going up and government spending is being severely slashed. The effect of this massive fiscal tightening is to slow down the economy. It just does not make sense.

This looks nothing like the bank bailout in the United States, in which the American government has thus far been able to provide massive fiscal stimulus while also rescuing banks. In that scenario, one can at least argue that the government is trying keep the economy moving. But one cannot convincingly purport that the Irish are trying to stimulate their economy by raising taxes and cutting government spending to fund Irish banks.

Perhaps the more convincing argument in favor of another Irish bank bailout is the notion that by providing liquidity to Irish banks, Ireland and the rest of Europe can avert any further "contagion". If Irish banks fail, investors may next lose confidence in Portugal or Greece. But we have heard that argument before. Just this summer, politicians argued that Europe must save Greece so that other countries do not suffer from a lack of confidence. So Greece was bailed out. But today confidence in Ireland, Portugal, Spain and Greece is nowhere to be found.

Forcing Irish bank bondholders to suffer losses will indeed cause financial turmoil around the world. However, that turmoil will cause less real economic pain than would be caused by forcing European taxpayers to foot an ever growing bailout bill.