Bailout sparks crisis in Ireland

The European Union’s promised bailout set off a political crisis in Ireland on Monday while it did little to calm market fears that Portugal — and possibly Spain — will be the next to need assistance.

The announcement of an estimated $109 billion package over the weekend to help Ireland bail out its failing banks provided only a brief respite to roiled world markets while it accelerated the political crisis in Ireland and appeared to seal the downfall of the unpopular government negotiating the bailout there.

Prime Minister Brian Cowen said he will call for an early national election next year — but only after Ireland’s parliament passes an emergency deficit-cutting plan required as a condition of receiving funds from the European Union and International Monetary Fund.

“Any further delay in this matter would in fact weaken our country’s position,” he said at a news conference in Dublin, explaining why he would not call for an immediate or snap election in the next three weeks, as demanded by some legislators. “Not to proceed with it would do grave damage to our interests.”

Mr. Cowen was forced to call the election after signs that his ruling coalition was breaking up over his bid for a bailout, which is viewed as a humiliation in what was formerly known as the “Celtic tiger,” Europe’s fastest growing economy.

Legislators from Mr. Cowen’s own Fianna Fail party called for his immediate resignation Monday, while labor unions and activists protested in the streets over the planned deep budget cuts. Protesters stormed Mr. Cowen’s offices in Dublin and scuffled with police.

Even as the looming bailout rocked the island nation, it failed to bring calm to world markets, as European officials had hoped. Investors already have turned their focus to worrying about the next candidates for a European bailout: Portugal and Spain.

“We are not overly confident that the announcement will bring an end to the sovereign debt crisis in the eurozone,” said Jay H. Bryson, an economist at Wells Fargo Securities. “We think it is likely that Portugal will eventually be forced to seek a rescue package.”

The yields on Portuguese bonds are hovering near all-time highs, just like Ireland’s, he noted, reflecting the judgment of investors that the country is overburdened and in danger of default.

“If yields remain at these levels, growth in Portugal would remain depressed for some time, which could eventually lead to a debt spiral,” Mr. Bryson said. He expects any rescue package for Portugal to be about the same size as the ones for Ireland and Greece.

“The announcement of aid for Ireland does not change the fact that Portugal and Spain both have high budget deficits, heavily leveraged private sectors and poor prospects for economic growth,” said David Watts, an analyst at CreditSights, citing the combination of factors that led to Greece’s and Ireland’s economic crisis.

Mr. Watts said investors remain concerned especially about the EU’s plans to force investors in an insolvent country’s debt to take losses as a condition of future bailouts under the EU’s permanent rescue facility to be set up in 2013.

The promise of such future “haircuts” means that investors will be willing to lend to those countries only for short periods of less than three years, forcing them to frequently roll over their debts to avoid paying exorbitant rates on long-term bonds, he said.

While the EU’s $1 trillion temporary bailout facility is large enough to accommodate Greece, Ireland and Portugal, coming up with a package big enough to rescue the much larger Spanish economy could be a challenge, economists say.

“A Spanish bailout would stress the facility,” said Mr. Bryson, although he added that Spain is in better shape than Ireland and appears able to fend on its own, for now.

“The Spanish government bond market has not melted down like the comparable markets in Ireland and Portugal,” he said. But even the mild increase in Spanish interest rates seen thus far, if sustained, eventually could force the government into a funding crisis, he said.

Paul Robinson, an analyst at Barclays Capital, called Spain “the final frontier” for the EU and its fledgling currency, the euro, which was introduced in 2002.

The euro has taken a pounding with each flare-up of the debt crisis this year. But so far the losses have been small compared to what would happen if Spain needs a massive bailout, he said.

“If confidence about the Spanish position were to deteriorate significantly, the euro would likely come under intense pressure,” he said.

As in past intensifications of the European debt crisis, the U.S. dollar and Treasury have been primary beneficiaries as investors flee into safe-haven investments. The dollar got a boost in recent weeks from Ireland’s woes, despite wariness in the markets about gigantic debt problems in the U.S.

“When the U.S. dollar does well, the euro tends not to,” said Mr. Robinson. But he said the U.S. may suffer next year when investors start focusing again on the burgeoning U.S. government debt and a controversial plan by the Federal Reserve to buy up much of that debt in the next eight months.