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Thursday
Nov182010

Europe Believes That Debt Crisis Is Ready To Spread

A newspaper vendor in Dublin on Monday.

LONDON — European officials, increasingly concerned that the debt crisis will spread, are warning that any new rescue plans may need to cover Portugal as well as Ireland to contain the problem they tried to resolve six months ago.

Each country would have to make a formal request for assistance before any plan would be implemented. And for months now, Ireland has insisted that it has sufficient funds to keep it going until spring. Portugal says it, too, does not need help and emphasizes that it is in a stronger position than Ireland.

While some important details are different, the current situation feels eerily similar to what happened months ago in Greece, where the cost of borrowing rose precipitously. European authorities ultimately stepped in with a rescue package, expecting an economic recovery and the creation of new European rescue funds to fend off future panics by bond investors whose money is needed by countries to roll over their debt.

But with economic conditions weakening, markets are once again in turmoil. Rescuing Ireland may no longer be enough.

Stronger countries and weaker countries that use the common currency of the euro are being pulled in different directions. Some economists even wonder whether unity will hold or whether some new system that allows countries to move on one of two parallel financial tracks is needed.

Despite the insistence of Irish officials that only its banks need additional help, investors continue to bet on an Irish rescue, driving down the bond yields on that country’s debt against a benchmark again on Monday.

Portugal’s yields, meanwhile, increased to 6.7 percent, underscoring the emerging concern in Brussels, the capital of the European Union, that it would be irresponsible to adopt a plan to prop up Ireland without addressing the possibility that turmoil could ultimately engulf Portugal, or even Spain. Like Ireland, Portugal has struggled to grow under the fixed currency regime of the euro. Though Portugal has raised sufficient funds of late from bond markets, its budget deficit is 9 percent of its gross domestic product, much higher than the 3 percent limit for countries in the euro zone. With its weak government and persistently slow growth, investors have grown fearful that Portugal, too, will eventually run out of funds.

While Ireland has largely impressed European officials with its commitment to austerity, Portugal has been lagging in this regard, according to European officials. One official in Europe, who asked for anonymity because he was not authorized to speak publicly, said that the budget recently presented by the government in Lisbon did not contain the type of far-reaching changes proposed by other countries, like Spain.

“If Ireland were to ask for aid, then you’d have to look at what’s going on in Portugal as well,” the official said, putting forward a view that to rescue Ireland alone would not keep speculators from zeroing in on other vulnerable countries.

José Manuel Barroso, president of the European Commission, said Monday that Ireland had not requested aid and stressed his faith in the strength of the single currency. “We have all the instruments to address the problems that may come either in the euro area or outside the euro area,” he told reporters in Brussels.

The Portuguese finance minister, Fernando Teixeira dos Santos, said Monday evening in Brussels that the situation in Ireland was creating dangers for all countries using the euro.

“If things are getting worse in Ireland, for instance, that will have a contagion impact on the other euro zone economies and particularly on those that are under closer scrutiny of markets, like Portugal,” he said. Asked if Ireland should accept a bailout to stem the contagion, Mr. Teixeira said, “It’s not up to me to make that assessment.”

Even so, Mr. Teixeira dos Santos emphasized that his country was not preparing to ask for a European rescue package. Portugal would “not necessarily” have to accept a rescue if Ireland did, he said.

Mr. Teixeira dos Santos also said his government was preparing a robust budget that would cut wages, freeze pensions and raise taxes. “We are really committed to meet our targets,” he said. “I think we deserve that the market gives us the chance to show that,” he said.

The bureaucratic machinations in Brussels highlight one of the main concerns that grew out of the establishment earlier this year of the 500 billion euro ($679.75 billion) rescue mechanism by the European Union after the Greek budget crisis: What happens if, during the next crisis, multiple countries need aid at the same time?

Months later, it remains unclear how, in practice, countries like Ireland and Portugal would tap the money that make up the rescue funds — the European Stabilization Mechanism and the European Financial Stability Facility — and how much they would draw from each pot.

Of paramount concern to policy makers in Europe is Spain, which is struggling to close its own deficit of 9 percent of G.D.P. at a time when unemployment is more than 20 percent and the economy failed to grow.

Just as the growing inability to get a precise reading on Ireland’s banking losses has propelled the Irish crisis, the extent of Spain’s own banking vulnerabilities — which, like Ireland’s, originate from a real estate boom and bust — remain unclear.

Until now, a series of austerity measures has allowed Spain to escape investor scrutiny. But late last week the spread, or risk premium, between Spanish and German bonds widened to an all-time high of 2.3 percentage points, underscoring investor fears of contagion.

Worries about the banks have peaked recently in light of data showing that distressed loans are now 5.6 percent of total Spanish bank loans — the highest level since 1996.

In Ireland, banking troubles lie at the root of what many in Europe are now calling a solvency crisis, reflecting long-term concern over Ireland’s ability to repay its debts, as opposed to the lack of short-term funds that forced the Greek rescue last spring.

“This policy of saving banks at the cost of breaking the back of entire countries is a disaster,” said Daniel Gros, director for the Center for European Policy Studies in Brussels. “Ireland is beyond fiscal plans as long as one cannot see the bottom of the losses in the banking sector,” he said. The only way to “stop the rot,” he added, “would be to let the Irish banks go under” and then use the European funds to “tide over the government until markets and the economy recover.”

Ireland is unlikely to let its banks fail, but it has been unable to accurately forecast its banking losses — and say whether bondholders will foot some of the bill.

Irish banking losses are estimated at up to 80 billion euros ($109 billion), depending on the forecast used, or 50 percent of the economy. As long as housing prices continue to fall, these losses cannot be capped.

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