By Howard Schneider and Anthony Faiola
Washington Post Staff Writers
Wednesday, November 17, 2010; A01
Ireland's debt crisis forced European officials into emergency talks Tuesday to try to contain the country's problems, as doubts surfaced about how an international fund established this year to help beleaguered European economies would work in practice.
Irish Prime Minister Brian Cowen acknowledged that his heavily indebted nation can no longer afford to borrow on world markets because it must pay such high interest rates, but he continued to insist that Ireland did not need a bailout. European officials, who were trying to hammer out a package of emergency assistance for Ireland, said they were fighting for the future of the European Union.
The latest turbulence highlights the apparent weakness of efforts taken in response to a similar debt crisis in Greece six months ago, which were aimed at reassuring investors that Europe's weakest economies would be protected from default. The $1 trillion fund set up in May by the Europeans and the International Monetary Fund was designed to calm fears that could unsettle world financial markets and undermine the global economic recovery.
Renewed concerns drove European markets down Tuesday and contributed to a sell-off on Wall Street, with the Dow Jones industrial average losing 1.6 percent.
The 16-nation euro currency zone is beset by fissures between strong economies such as Germany and weaker ones such as Greece, Ireland and Portugal, which risk being engulfed by historic levels of government debt. European Union Council President Herman Van Rompuy warned of "a survival crisis" for the currency union and the E.U.'s broader experiment in economic and political integration.
E.U. economic affairs chief Olli Rehn confirmed that Ireland was in crisis talks with the European Central Bank, the European Commission and the IMF. The IMF said it was sending a team for a "short and focused consultation" at Ireland's invitation.
With the economic recovery flagging, U.S. Treasury Secretary Timothy F. Geithner called on European leaders to take urgent action.
"You want to make sure you move very, very quickly and you have a combination of policy reforms that help resolve the underlying problem, with some temporary financial support to help countries manage through them," Geithner said at a symposium sponsored by the Wall Street Journal.
Although Ireland is a small economy, economists warn that banks and other firms that have lent it money could be endangered if it cannot make scheduled payments. This could unsettle the financial system beyond the country's borders.
Bank of England Governor Mervyn King, for instance, warned that Britain's "overall exposure to the Irish economy is by no means trivial." He said troubles in Ireland could undercut already weak growth in Britain, the world's sixth-largest economy and home to a number of major world financial firms.
These concerns about financial contagion are more muted than was the case with Greece. Ireland has enough cash on hand to pay its bills through the middle of next year, while Greece was facing a deadline to refinance part of its debt and was struggling to raise the money it needed.
U.S. officials said they saw little risk directly from Ireland for the U.S. financial system, because American banks and other firms are not heavily invested in Irish government bonds or the country's economy. But economic upheaval in Europe could still help snuff out an anemic recovery in the United States.
With interest rates spiking for bonds issued by Ireland and Portugal, which is also heavily indebted, the officials holding discussions in Brussels warned that Europe has not made enough progress in addressing its government debt and economic problems.
Although the $1 trillion fund was established to reassure markets that Europe as a whole would stand behind the debts of its weakest members, it remains unclear how countries will gain access to any needed funds and on what terms.
Germany recently suggested that private investors, ultimately, would have to pay for part of any bailout through a reduction in the value of their government bond holdings. This proposal unnerved markets, highlighting that the terms of Europe's crisis response remain unclear.
"The question that the markets are asking is: What is ultimately the policy framework for the euro zone?" said Nicolas Veron, an analyst with the Bruegel think tank in Brussels. That will require final decisions on some of the euro zone's most sensitive issues - chiefly the degree to which stronger nations such as Germany should underwrite weaker ones with which they share the euro.
Officials meeting in Brussels want to press Ireland and Portugal to outline how they plan to trim their massive government budget deficits. Both may need help from the European bailout program and the IMF, though both countries are reluctant to ask for it.
Ireland does not need immediate cash assistance and is worried that under the terms of the bailout it could be forced to give up policies such as a low corporate tax rate that Irish officials regard as important for future growth.
But the future fiscal health of the Irish government is less certain because Ireland is undertaking an expensive bailout of its failing banks and has taken over tens of billions of dollars of potentially bad real estate loans. Other European nations are pushing Ireland to accept assistance now rather than letting the problem fester, which could reinforce doubts about the health of other troubled economies and the euro's stability.
"The Irish government in the coming days has to make a definite decision on this," said Luxembourg Prime Minister Jean-Claude Juncker, who led the meeting of European ministers.
The emergency discussions, expected to last two days, are a test of whether Europe has reached a consensus about how to confront its financial and economic problems. Many European governments are scaling back programs to tame large government deficits, but some are engaged in a more fundamental restructuring of social expectations and programs.
While Greece has been undoing long-cherished welfare and employment rules, Ireland is confronting economic collapse. Ireland's once highly competitive perch in the global economy has given way to falling incomes and property values. International investors, who helped Ireland boom, are abandoning the country. Ireland has spent $68 billion to rescue its banks, driving its expected government deficit this year to about 30 percent of the economy - 10 times the target set for euro-zone countries.
In a series of recent analyses, the IMF has warned that the bank bailouts, government debt and a declining economy will make it tough for Ireland to stabilize itself.
Analysts said Ireland, to quiet the current crisis, may have no choice but to swallow its pride and accept help.
"For the good of the euro zone, Ireland should formally accept an 'E.U. bailout' even if it does not need the money until mid-2011, as this will demonstrate clear support and reduce contagion and current anxiety-driven yields," Sonia Pangusion, senior Irish analyst for consulting firm IHS Global Insight, said in a research note Tuesday.
Faiola reported from London. Staff writer Neil Irwin contributed to this report.