World's Biggest Banking Black Hole in Ireland

It's the world's biggest banking black hole - and it's in Ireland, one of Europe's most troubled economies.

The debt disaster at Anglo Irish Bank means that Ireland is tasked with carrying out the continent's most ambitious bank-bailout program at a time of surging deficits and welfare lines. The unrelenting tide of red ink has analysts and Dubliners alike asking: How on earth will Ireland keep paying its bills?

"Every man, woman and child walking down that street out there has been put in a deep, dark hole by the bankers. We've all been given a bill we can't pay for a hundred years," said John Doyle, a car mechanic patching a flat tire at his backstreet Dublin garage.

At the center of the crisis is Anglo, a specialist lender that bet all its chips on a runaway property market during Ireland's boundlessly optimistic Celtic Tiger boom of 1994-2007.

Ever since the global credit crisis plunged the economy into reverse two years ago, unemployment has tripled to 13.8 percent, private construction activity has collapsed, tax collections have shriveled and the national deficit has swelled to the largest in percentage terms in Europe.

"You wonder if Ireland is going down the same route as Greece. The country is hemorrhaging money at an alarming rate," said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin.

The government of Prime Minister Brian Cowen has won plaudits internationally for its swift intervention since 2008 to prevent bank failures and fight the deficit with severe cuts in ordinary people's incomes. Cowen, the European Union and International Monetary Fund agree that Ireland must keep cutting spending by at least euro3 billion next year - but the ballooning cost of saving Anglo keeps undercutting that effort.

So far, the government has thrown euro35 billion ($45 billion) into Irish-owned banks, about two-thirds of that into Anglo alone, in hopes of preventing the chaos that followed the U.S. collapse of Lehman Brothers. In doing so, it offered a Europe-unique blanket guarantee to pay back international holders of all Irish bank-issued bonds, rather than let Anglo fail and let its investors stomach the losses.

But many, even within Cowen's own coalition government, now criticize that guarantee as recklessly generous, and question whether Ireland would be better off making Anglo investors bear at least some of the losses.

The government initially hoped to limit its support for Anglo to euro3.5 billion, but nationalized the bank outright after uncovering massive loan malpractice. Taxpayer support has reached nearly euro23 billion - and, after initially billing this bailout as an investment, the government now concedes the money won't be coming back.

In July, The Banker magazine rated Anglo as recording the worst 2009 losses among all of the world's banks. It's on course to repeat the feat this year, announcing euro8.3 billion in loan losses Tuesday for the first six months of 2010 alone.

International investors led by ratings agency Standard & Poor's think the ultimate Anglo bill to Irish taxpayers will reach euro35 billion, equivalent to 20 percent of the Irish economy, if the government stays the blanket-guarantee course.

While the government's publicly favored option is to split Anglo into two - a "bad" bank that would handle the taxpayer-funded dumping of failed loans, and a solvent bank that receives the profitable 20 percent of its loan book - Cowen now is hedging his bets and using European Union supervision as possible cover.

"The government is united in its determination in relation to the resolution of the Anglo Irish Bank issue - that it must be done at the least cost to the taxpayer and in a way that gives finality. The government is working with the EU authorities to that end," Cowen's Cabinet said after a meeting Wednesday to discuss the crisis.

Analysts expect the European Commission in Brussels to offer at least partial support to the government's plan to split Anglo in two, but could demand that European bondholders in Anglo take their lumps rather than accept Ireland's get-out-of-jail-free card.

"Brussels probably will back Ireland's plan for a good bank-bad bank split of Anglo. But you can't dismiss the chance they'll say enough's enough, the numbers are that bad," said McQuaid.

He suggested that Brussels could order the kind of punishment of Anglo's European bondholders that Ireland - determined to preserve its reputation as a responsible borrower - has avoided.

"If we were to go ourselves to Anglo bondholders in Britain, Germany, France and Spain and say we're not going to pay, that would have a huge negative effect. Our bond yields would go through the roof," McQuaid said. "But if the EU ordered the move, it wouldn't have the same destructive effect."

As it is, the uncertain cost of propping up Anglo has already made investors deem Ireland an increased investment risk for borrowers. Last week S&P lowered Ireland's credit rating again, citing its bank bailout program.

The gap between the interest rates charged on Irish and benchmark German government bonds rose to a record high of 3.5 percentage points. This means it's getting progressively more expensive for Ireland to pay interest on its borrowing from international bondholders.

And Irish banks face their greatest test of faith this month, because they need to refinance euro25 billion in debts that come due for repayment worldwide. Analysts expect the banks to find buyers for their bonds at the cost of offering above-market interest rates.

The taxpaying public, which has glumly swallowed two years of income cuts and tax hikes as part of deficit-fighting measures expected to continue through 2013, sounds fed up with the cost of saving Anglo and doubts the ability of their own government to cope.

"Hopefully the IMF and EU will run this island for the foreseeable future," said one poster on Wednesday's online discussion of the Anglo crisis on The Irish Times' Web site.

Doyle, the Dublin mechanic, figures the patience of Irish society could snap soon. He says the nation's belt-tightening and recession have cost him half his income versus the heady days of 2007, when Anglo was still feeding a property frenzy with cheap, ill-secured credit and its directors were hiding their own massive loans from shareholders.

"People say we'll never riot like the Greeks. I'm not so sure," he said, shaking a wrench in his grease-blackened hand.

"All them Anglo fat cats should be in jail. They'll never do a day, the way our stinking system here protects the rich," he said. "They're keeping their mansions, their tax shelters, their Mercedes in the drive while the nation goes to the wall. It makes you sick thinking about it."