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Irish political turmoil complicates financial-system fix

European diplomats Monday applauded Ireland's decision to accept a loan to prop up its ailing banks. But the Irish finance minister warned the country's banks will need to be pruned, merged or sold.

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Washington Post Staff Writer
Monday, November 22, 2010; 8:56 PM

One day after requesting a bailout worth more than $100 billion, financially troubled Ireland plunged deeper into a political crisis that could complicate a rescue deal with the International Monetary Fund and European Union.

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At the same time, concern mounted that attempts to prevent a broader regional debt crisis by shoring up near-bankrupt Ireland may not be enough to prevent the need for more bailouts in ailing Portugal, and perhaps even for the far larger economy of troubled Spain. Coupled with the worsening political turmoil in Ireland, those fears dashed hopes of a market rebound on Monday, rattling stock markets and causing the euro to lose ground against the dollar after initially posting a slight rise.

In Dublin, Prime Minister Brian Cowen, under fire for mishandling the crisis, said he would step down early next year. But he resisted calls to tender his resignation immediately, vowing late Monday to remain in office and push through an austerity budget next month that is considered essential to clinching the rescue deal.

The political crisis potentially poses a new complication in efforts to shore up Ireland. With banks buckling under the weight of a colossal real estate bust, the government is in tense negotiations with the IMF and E.U. over the bailout's size and conditions. European leaders are pressuring Ireland to reach agreement quickly to bolster market confidence in other debt-wracked countries in the region, as well as to prevent the euro from destabilizing. Britain and Sweden pledged direct loans to Dublin on Monday.

Cutting government spending will probably be a cornerstone of the deal. And it remains unclear whether Cowen, whose coalition has a slim majority in parliament, can still muster the votes needed to pass the budget. He called on parliament to show political courage when legislation is presented Dec. 7.

"We are focused on an issue of great national importance," Cowen told reporters in Dublin. "And the biggest statement that can be made in this country at this time is to pass this budget."

Cowen's junior partner in his ruling coalition - the Green Party - triggered the deepening crisis by announcing it would withdraw its support and force new elections. Although the party vowed to support the budget vote, its move prompted the opposition to renew calls for Cowen to step down.

Even some members of Cowen's party were reportedly reconsidering their positions on the unpopular budget given the new elections. It also remained unclear how any new government would view a deal struck between the Cowen administration and the IMF and E.U. Among the opposition, the center-left Labor Party has called for softer budget cuts, while the center-right Fine Gael Party is seen as largely backing the austerity drive.

"It's opening up yet another kind of risk in Ireland," said Jan Randolph, head of sovereign risk at IHS Global Insight in London. "Even if you get a deal, you need a solid, supportive government to execute it."

But Fine Gael leader Enda Kenny called new elections essential to restoring the public's confidence in the government and securing a long-term bailout. Cowen, who denied for days that Ireland was lurching toward a bailout, had lost the faith of the public, he said.

"What is needed now is an immediate general election so that a new government, with a clear parliamentary majority, can prepare the four-year economic plan, complete negotiations with the E.U. and IMF and frame a budget for 2011," Kenny told reporters in Dublin.

While European governments may have dealt with the immediate crisis facing Irish banks, the greater challenge for European governments will be ensuring that no nation defaults on its debts or drops use of the euro, the common currency.

"At best this is a patch," said Desmond Lachman, a resident scholar at the American Enterprise Institute. "Like with Greece, they gave them money, and conditions improved for a while, but now they're back to where things were before the IMF came in. And the same thing will happen in Ireland. They're kicking the ball down the field."

The political turmoil in Dublin undermined a hoped-for bounce in the markets from Sunday's bailout news. Instead, investors sold off Irish bonds, particularly after a Moody's report suggesting that Dublin could be subject to further credit downgrades even with a bailout. The interest rate the Irish government must pay to borrow money for 10 years fell by only 0.04 percentage point, despite the bailout news, and its rate, 7.9 percent, remains five percentage points higher than what financially stable Germany must pay.

In Lisbon, Prime Minister Jose Socrates on Monday sought to counter market rumors that his nation was next in line for a bailout. Portugal "has no need for any aid," he told reporters. Nevertheless, investors remained worried about Lisbon's ability to meet its target to cut its deficit down to sustainable levels.

"There are no links between Portugal and Ireland," Socrates said.

faiolaa@washpost.com Staff writer Neil Irwin in Washington contributed to this report.

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