More Investors Betting Ireland Will Go the Way of Greece

Sep.29.10 | About: iShares MSCI (EIRL)

By Don Miller

The cost to insure Irish bonds against a government default jumped to a record Tuesday after Standard & Poor's said the cost of bailing out nationalized lender Anglo Irish Bank Corp. could exceed $47 billion. Contracts on credit default swaps (CDS) on Anglo Irish bonds rose 1.5 basis points to 937.5, implying a 56% probability of default within five years, after earlier climbing to an all-time high of 960.5.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. Increasing prices signal deteriorating credit quality. Investors are speculating the nation's government will be unable to contain the ballooning cost of rescuing Dublin-based Anglo Irish. They also fear the government may decide it can't repay senior bondholders and still overcome the Eurozone's biggest budget deficit.

"The cost of the Anglo Irish bailout is too high for Ireland to afford without jeopardizing its fiscal position." Greg Venizelos, a credit strategist at BNP Paribas SA in London told Bloomberg News. "It's a key test for the market,"

European governments continue to struggle to fix their finances and stave off a collapse of their banking systems after a sovereign debt crisis roiled markets last spring. The speculation about Ireland spread to the rest of the region, driving up CDS' on other governments and banks. The Markit iTraxx SovX Western Europe Index, which tracks default swaps on 15 governments, rose 3.5 basis points to 163.5.

Credit-default swaps on Portugal increased close to May 6's record-high closing price of 461, while Greece climbed 7 basis points to 823 and Italy was up 4.5 basis points at 201. Spain added 7.5 basis points to 235. The yield on Ireland's two-year government note rose as much as 46 basis points to 4.7%, Bloomberg data show.

As it struggles to retain the confidence of bond investors, the government faces a battle to maintain its majority in the Dail, the nation's parliament, which reconvenes today after a 12-week summer break. The Fianna Fail-led coalition government is made up of the Green Party and a number of independent lawmakers not associated with any party. Between them, they have a narrow lead of 84 seats against 78 for the combined opposition.

Fianna Fail has insisted that the government will complete its five-year term ending in 2012, but Finance Minister Brian Lenihan's forthcoming budget is proving increasingly unpalatable to some members of his own party, The Wall Street Journal reported.

Lenihan will review forthcoming economic releases before finalizing his economic growth forecast for the year ahead before releasing his budget on Dec. 7. He has already announced a "minimum" of $4.04 billion (3 billion euros) in cuts. "The consensus now is for a general election in the spring of 2011. The likelihood of this government going to full term is looking less and less possible," David Farrell, professor of politics at University College Dublin told The Journal.

Putting a final price tag on the cost of bailing out Ireland's crippled banking system will be one of the biggest pieces of news for the government after it reconvenes. It has already pumped around $44.3 billion (33 billion euros) into the system, roughly 20% of gross domestic product (GDP). The deficit is expected to reach 25% of GDP this year, including the cost of restructuring Anglo Irish.

The bank has already cost the country $30.75 billion (22.9 billion euros). Moody's Investors Service lowered its rating yesterday on the senior un-guaranteed securities of the Dublin-based lender. The Central Bank of Ireland is expected to come up with the estimated "final" cost of supporting the bank as early as this week, possibly Thursday.

But the days ahead are packed with additional data that could help topple the government. The September jobless report on benefit payments also comes out Wednesday, with an update on the jobs picture after the government reported a staggering 13.8% unemployment rate in August.

On Friday, the Central Bank of Ireland releases its quarterly bulletin of commentary and forecasts, followed Monday by a report on government borrowing for September which will give a clearer picture on the government's budget deficit and tax receipts.

Disclosure: None

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