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As the bailout of Ireland and its banks moves forward, it is important to ask if 100 billion euros, let alone the 80 billion euros rumored to be in the bailout, enough to solve the Irish crisis.

Clearly, investors lost confidence in the Irish government and its ability to manage the problem of bad assets in its banking system.

Unlike the rest of Europe and the US, the Irish government made the decision to remove all the bad assets from its banks. To do this, it used a good bank/bad bank concept. In theory, the private banks would hold good assets and a government set up bad bank would hold the bad assets.
To be successful, the good bank/bad bank concept required that all the bad assets be identified and transferred in one shot. Unfortunately, there were three separate rounds of bad asset purchases. Each round, the bad asset purchases were done at a steeper discount. The combination of multiple rounds of purchases and the increasing discount on the assets purchased invited an erosion in investor confidence.

Investors began to question both whether the government could get its arms around the problem and what was the actual size of the problem.
Further eroding investor confidence, the Irish government has been claiming for weeks that it did not need a bailout. Now, under pressure from other European Union finance ministers it is acknowledging it needs a bailout.

But what size bailout is really the right size?
  • From the investor's perspective, in the absence of current performance information on the underlying assets so they can independently value the assets, once a devaluation cycle starts, there is no logical stopping place for valuations other than zero. This suggests a bailout that is approximately equal in size to the current book value of the assets. Is the current book value of all the bad assets in the Irish banking system approximately 80-100 billion euros?
  • If not, how was the size of the bailout arrived at given that there is a potential several hundred billion euro hole in the Irish bank balance sheets?
    • What source of information did the finance ministers for the other European countries have access to that supports this size bailout? How could it support this size bailout if the Irish government also had this same information and claimed they did not need a bailout?
    • Is this the amount that the finance ministers felt investors needed to hear? Is this revisiting the Hank Paulson Bazooka and trying to convince investors that overwhelming firepower had been made available to deal with the situation?
    • Is this all the financial support that the European Union could offer knowing that there are other bailout candidates in the wings?
At the start of the global credit crisis, bailouts were used to allay investors concerns and try to buy time in the hope that the economy would recover and drive up the cost of the underlying assets. Is this another round of that strategy? Is there any reason to believe that it will work this time?

Why do governmental officials prefer to throw taxpayer money at this problem rather than provide the information the markets need to determine if there is a problem and if so how big a problem there is?


Author's Disclosure: no positions

Source: Is 100 Billion Euros Enough to Solve the Irish Crisis?