The EU Commission and the ECB seem to believe that further budgetary corrections, as envisaged in the Memorandum of Understanding and accepted by the Irish Government, will see Ireland re-enter the bond market successfully in the second half of 2012.Virtually all bank bondholders will be paid back along the way and the banks will have been recapitalised and will be able to fund themselves.
If the markets, which Ireland must re-enter within 18 months, believed all of this, then Irish 10-year bonds would not be offering yields of 10.6 per cent, as they were on Friday.
If the markets do not believe that the exit strategy (a successful return to the markets before the end of 2012) is credible, then the game is already up.
What, precisely, do the EU and ECB expect to happen that will change this scenario?
In the Irish case (but not the Greek), outstanding debt includes enormous obligations to repay bank bondholders. These were imprudently undertaken by the Government in the belief that the banking problems were much smaller than they actually are.
The result is that Irish taxpayers have already transferred substantial sums to investors who made losing bets on Irish bank bonds and they are expected to make further transfers in the future.
Some of the banks whose bondholders have already been paid off have lost eight and 10 times their equity capital. The perception that the costs of the European banking crisis are being borne disproportionately by Ireland is corrosive of public support for desirable policy reform.
Economist Paul de Grauwe has argued that the very design of the eurozone created high risks of sovereign default for non-core EU members who were rash enough to join the single currency.
It is patently clear that these risks were under-appreciated in Ireland but it is dispiriting to have to listen to lectures from ECB officials who appear to regard the European banking crisis as essentially a morality play about fiscal policy.
The policy reforms designed to prevent another crisis are worthy and may work. But unless the European banking crisis is acknowledged and dealt with soon, we are witnessing a slow-motion train-wreck that will end badly for Ireland, for several other eurozone members and ultimately for the entire European project.
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