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February 16, 2009

Ireland Riskier than PIGS

The Republic of Ireland’s announced yet more measures to support its tormented banking industry. The government said it would invest EUR3.5 billion in each of Bank of Ireland and Allied Irish Bank, the country’s two largest banks. The EUR 7 billion cash injection will be funded from the taxpayers’ money – or as the official news state – from the state’s pension reserve.

In return, the state will receive preference shares that pay annual interest of 8%. Still no mention of what the taxpayers’ will receive in return, other than the bill of course! The government will also get warrants giving it an option to buy ordinary shares that will take its stake in the banks to 25%.

The credibility of Ireland’s banking system is torn apart following corruption allegations at the nationalised (since last year) Anglo Irish Bank. The amount of financial assistance the state has given to support the banking sector has put significant strain on its finances.

Ireland’s CDS spreads are now the highest in the Eurozone, exceeding the so-called PIGS (Portugal, Italy, Greece, Spain) and even wider that the newest entrants Slovenia and Slovakia. CDS contracts are usually traded for protection and the higher the credit default swap spread the higher the perceived risk by the market. Ireland is now seen as more likely to default by the market than the aforementioned PIGS and therefore a higher fee is being charged in order to protect against this event.

The expansion of the balance sheets of Aaa-rated governments as a result of large-scale state interventions to support local industries – also referred to as the “socialisation of risk” – has prompted Moody’s Investors Service to tackle the question of whether government debt is still the ultimate sanctuary for investors.

The wide-scale “risk socialization” that began more than a year ago – with governments deploying their balance sheets and raising public debt – is now reaching historic proportions. Poor earnings and weak economic data cemented negative sentiment and trends in January and early February are as bad as or worse than November-December, suggesting that the first quarter of 2009 is going to be worse than the last quarter of 2008.

The world economy feels as being in free fall, looking for a bottom that it can’t yet see. The Search for Honest Earnings Reports will be the longest ever… and is likely to resemble the Search for the Meaning of Life.

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