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Irish Rescue Fails to Stem Turmoil; Spain Bonds Drop

Germany's Chancellor Angela Merkel
Finance chiefs also endorsed a Franco-German compromise on post-2013 rescues that means investors won’t automatically take losses to share the cost with taxpayers as German Chancellor Angela Merkel initially proposed to the consternation of bond traders. Photographer: Jochen Eckel/Bloomberg

European governments’ 85 billion- euro ($113 billion) bailout package for Ireland failed to quell the market turmoil menacing the euro as stocks, bonds and the currency declined.

Irish 10-year bonds slid after an early advance, Spanish bonds fell by the most since the euro’s launch and European shares sank 1.4 percent. The euro weakened against 15 of its 16 major counterparts and the cost of insuring the debt of Spain and Portugal against default soared to records.

“The notion that a rescue package for Ireland would create a firewall and stop the fear of contagion is clearly discredited,” said Preston Keat, director of research at Eurasia Group, a political consultancy, in London. “Portugal and Spain are already facing pressures in the markets.”

Six months after the Greek rescue exposed flaws in the euro’s makeup and fueled doubts whether 16 countries belong in the same currency union, policy makers again found themselves meeting on Sunday in Brussels racing to calm markets.

In addition to Ireland’s rescue package, finance chiefs also endorsed a Franco-German compromise on post-2013 rescues that means investors won’t automatically take losses to share the cost with taxpayers as German Chancellor Angela Merkel initially proposed to the consternation of bond traders. And Greece was told it could have an extra 4 1/2 years to repay emergency loans to match the seven-year term in the Irish deal.

Most-Indebted Nations

The moves failed to ease concern the region’s most-indebted nations will need further aid. The euro slid 1.1 percent to $1.3101 against the dollar at 4:31 p.m. in London, reaching its lowest since Sept. 21. The Stoxx Europe 600 Index retreated 1.4 percent to 262.83.

The yield on Spanish 10-year bonds rose 25 basis points to 5.46 percent, the highest since 2002. That pushed the premium over German bunds to 271 basis points, a euro-era record.

Credit-default swaps on Portugal jumped 37 basis points to 539, and contracts on Spain climbed 28.75 to 351.5, according to CMA. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments increased 9 basis points to a record 197, based on closing prices.

While Greece let its budget get out of hand and Ireland fell prey to a housing bust, Portugal suffers from a lack of competitiveness that kept average economic growth below 1 percent in the past decade. Its government has also been slower to cut its deficit than others, with the central government’s shortfall widening 1.8 percent in the first 10 months of the year as Spain’s fell 47 percent.

Bond Sales

Like Ireland, Portugal doesn’t immediately need money to run the government. It has completed this year’s bond sales and doesn’t face a redemption until April. The government debt agency plans to hold an auction of 12-month bills on Dec. 1.

Portugal last week passed the deepest spending cuts in more than three decades with the goal of getting back under the EU’s deficit limits by 2012. HSBC Holdings Plc estimates it needs to find 51.5 billion euros over the next three years to meet its likely budget and bond redemption needs.

“Portugal doesn’t see a need to ask for help,” German Finance Minister Wolfgang Schaeuble said yesterday.

Spanish Economy Minister Elena Salgado also reiterated that her economy -- the euro zone’s fourth-largest and almost twice the size of Portugal, Ireland and Greece combined -- won’t need aid either. As well as slashing its budget gap, the country has brought regional spending under greater control and half of its debt is held at home, limiting the threat of a withdrawal by foreign investors. It doesn’t face the first of its 45 billion euros in bond redemptions next year until April.

Bailout Pot

Investors have nevertheless expressed worry that the EU’s bailout pot may be smaller than advertised and not large enough to save Spain. HSBC’s sums show the country needs 351 billion euros over the next three years.

In practice, the EU may only be able to deploy 255 billion euros of the 440 billion-euro European Financial Stability Facility, according to Nomura International Plc. That’s because the rescue fund is financed by issuing bonds and to secure a AAA rating, governments agreed to set aside cash and to link lending to the creditworthiness of donors. The rest of the bailout pool consists of 60 billion euros from the European Commission and 250 billion euro pledged by the IMF.

UBS AG said in a report published today that the debt crisis will escalate next year and that investors should continue to avoid bonds issued by so-called peripheral countries like Ireland, Portugal and Greece in the near term.

Domestic Criticism

Germany, which built the euro on the principle of budgetary rigor, unleashed the latest phase of the crisis by demanding a “permanent” system as of 2013 that would enable fiscally troubled countries to restructure their debts and cut the value of bond holdings.

The German push ran into criticism from policy makers elsewhere, who called it mistimed, and from European Central Bank President Jean-Claude Trichet, who warned it would unsettle bondholders. Merkel, who has faced domestic criticism for aiding EU neighbors, yesterday backed away from the pitch for an automatic penalty, agreeing to give the International Monetary Fund a role in determining losses on a case-by-case basis.

The new proposal, fast-tracked from a debate set for December, would introduce “collective action clauses” for debt sold as of 2013, enabling fiscally hard-hit governments to renegotiate bond contracts. EU governments aim to enshrine it in the bloc’s treaties by mid-2013 and pair it with a new emergency liquidity fund to replace the one expiring then.

‘Herd Behavior’

Trichet yesterday called the compromise a “useful clarification” and the ECB’s Governing Council said that the Irish program will “contribute to restoring confidence and safeguarding financial stability in the euro area.”

“There’s plenty of herd behavior in the market,” EU Economic and Monetary Affairs Commissioner Olli Rehn said. “We want to clarify any possible confusion.”

Germany’s export-led economy has powered through the euro crisis, with business confidence at a record high in November and the government projecting expansion of 3.7 percent this year, the fastest pace in more than a decade. That resilience contrasts with recessions in Greece and Ireland, splitting the euro region between better-off countries in Germany’s economic slipstream and poorer ones on the continent’s fringes.

Yesterday’s decisions “do not address long-term solvency issues,” said Andrew Bosomworth, a Munich-based fund manager at Pacific Investment Management Co. “It’s a kick-the-can-down-the-road solution as opposed to acknowledging and confronting the here-and-now insolvency problems.”

Cash Reserves

Ireland said it will pay average interest of 5.8 percent on the loans, which break down into 45 billion euros from European governments, 22.5 billion euros from the IMF and 17.5 billion euros from Ireland’s cash reserves and national pension fund.

“I don’t believe there were any other real options,” Irish Prime Minister Brian Cowen told reporters in Dublin.

A day after more than 50,000 protesters marched through Dublin to denounce Cowen’s budget cuts to stave off financial ruin, the EU gave Ireland an extra year, until 2015, to get its budget deficit to the euro limit of 3 percent of gross domestic product.

Including the bill for propping up Irish banks, the deficit is set to reach 32 percent of GDP this year, the highest in the euro’s 12-year history.

Emergency Measures

Cowen has overseen the collapse of Ireland’s banking system and public finances, leading to recession and unemployment near 14 percent. Cowen’s government is also unraveling. The Green Party, a junior coalition partner, wants elections in January, his party last week lost a special election for a vacant parliamentary seat and some of his own colleagues are slamming his leadership.

Close banking links led Britain, a non-euro user that didn’t contribute to Greece’s 110 billion-euro rescue in May, to contribute 3.8 billion euros to Ireland’s package.

The reigniting of the crisis means the ECB may again postpone its exit from emergency measures just as it did at the height of the Greek turmoil. It’s likely to also provide more help to banks in Spain and Portugal and could ultimately extend its bond-purchase program to Spanish securities and maybe even conduct broader asset purchases, said Janet Henry, chief European economist at HSBC in London.

“We removed doubts and uncertainty and we must keep removing reasons to panic; we aim to take away speculators’ tools,” Finnish Finance Minister Jyrki Katainen told reporters in Helsinki today. Still, “there is no guarantee the crisis won’t continue, or even spread, despite the Irish loans.”

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