NEW YORK (
) -- As expected, shares of the few remaining large, financial services firms in Ireland that are still publicly traded took a beating on Monday, after the Irish government acknowledged the banks' need for a public bailout.
The news and related speculation dragged down shares of large European banks not based on the Emerald Isle and held down the U.S. stock market as well.
What's been lacking from most of the news coverage of Ireland's dilemma is the answer to a couple of simple questions: What's wrong with the Irish, and why should investors outside of the
Bank of Ireland
Allied Irish Banks
Irish Life & Permanent
be concerned? It seems that, in a now-familiar plotline, what started out as a decline in real-estate values has led to a crisis of confidence and an international bank-stock sell-off.
First, the news.
After denying Ireland's need for assistance for weeks, Ireland's finance minister, Brian Lenihan, said on Sunday that the government would formally seek international aid. During an interview with RTE Radio, Lenihan said Ireland would ask for "tens of billions of dollars" from the European Central Bank (ECB) and International Monetary Fund (IMF).
"Whatever figures are arrived at will not necessarily be drawn down," said Lenihan. "It's a figure to demonstrate the kind of support that's available to back up the Irish banking system as part of the euro system."
He also said that Irish banks are currently operating with "massive support" from the ECB.
The doom-and-gloom comments led to a sharp sell-off in the few remaining Irish financial stocks: Bank of Ireland tumbled nearly 19% in early trading. Its U.S.-listed shares were recently down 16.1% at $2.24 on the New York Stock Exchange. AIB was shedding 4.5% at $1.17 while Irish Life & Permanent, which is now relegated to the pink sheets, was down 12.6% at $1.25.
There were ripple effects outside of the Emerald Isle as well.
National Bank of Greece
was hardest hit, down 6.5% at $1.87 in recent trading. Its government similarly denied the need for support before seeking $110 billion in foreign aid in May. U.K.-based
was shedding 5.2% at $4.05 and
Royal Bank of Scotland
was down 4.9% at $12.74.
U.S. stocks were lower, too, with
Bank of America
losing the most ground in major indices and other big banks with foreign exposure - like
- falling even harder.
Stock investors would be right to wonder how a little island off the coast of mainland Europe could cause hundreds of billions of dollars' worth of market value to evaporate in hours - and whether the Ireland crisis represents a warning signal or a buying opportunity. Here's what happened in Ireland.
Much like the U.S., Ireland saw great declines in real estate values and an economic slowdown after a long period of strong economic growth. (Here, it was called the subprime bubble. There, it was called the Celtic Tiger.)
However, unlike the U.S., Ireland doesn't have a triple-A credit rating that might as well be guaranteed by major debt-ratings agencies. That means its government can't borrow endlessly to repair the problem of its own accord.
"Part of this situation is a bit of a self-fulfilling prophecy: As soon as people start focusing on a particular country, there's an immediate impact on that country's ability to raise debt in the market," says Brett Barragate, who consults with big banks about capital issues as practice leader of the Financial Institutions Litigation & Regulation practice at law firm Jones Day. "In the case of Ireland, just as it was in the case of Greece, as soon as people started focusing on it and it fed on itself, in both cases, they were basically shut out of the financing markets. The cost of them raising debt was excessive, so it almost created the crisis."
Additionally, Ireland's pre-crisis growth was supported by incredibly low corporate tax rates that encouraged businesses to set up shop in the Dublin environs. Since the government will have to get its financial house in order somehow, it's unclear how sustainable those tax rates will be.
On Sept. 30, the Irish government outlined a $47 billion bailout for its banks and a plan to reduce the deficit to less than 3% of gross domestic product by 2014. But the market wasn't buying it.
Borrowing spreads for Irish banks continued to widen and the cost of protecting against default increased. Their stocks continued to slide lower. By last week, it became clear that depositors were scared, too. AIB said on Friday that it had lost 17% of its deposit base since June.
Questions about Ireland's ratings, its outlook and its ability to fix the problem created a situation evocative of
in the fall of 2008. What began as a decline in real-estate values turned into a self-fulfilling confidence drain regarding Ireland which, in turn, led investors to question other banks' exposure as well.
For instance, as Edward Harrison, a banking and finance specialist at the economic consultancy Global Macro Advisors,
points out, both Bank of Ireland and AIB passed
supposedly strenuous, supposedly forward-looking European stress tests conducted earlier this year.
"Clearly, the tests were not very stressful given the Irish bailout - more so, given the Irish government carried out more severe tests in March," Harrison writes on a blog for Roubini Global Economics.
Now that investors can't trust the stress test results - and are freaking out about the exposure in relatively-small Ireland - it could lead to more damage in bigger countries that are equally or more vulnerable. Among those are nations besides Ireland and Greece in the so-called "PIIGS" group: Portugal, Italy and Spain.
Taking it a step further, E.U. nations that are financially secure, but tied to their profligate neighbors, appear to be at risk as well. Germany is considered the most conservative and stable E.U. nation. Yet Frankfurt-based
was down 2.7% at $54.02 in recent trading, after its government said German banks could get hit by Ireland's debt woes. A spokesman later told
that Deutsche Bank's exposure to Ireland was less than 400 million euros. But if even Germany is exposed to Ireland's woes, is anyone really "safe"?
"I don't know if they would have worked it out on their own or not," Barragate says, referring to the troubled twins, Ireland and Greece. "The issue is, nobody really knows the extent of the issues they potentially have. A lot of it is tied to real estate and those type of assets take a long time to work through. It's very hard to tell, but in some sense you're right - focusing on a country in particular creates another problem that needs to be solved."
But there's a good chance that all that speculation and bearishness is for naught. Some investors are following
trusted advice to be brave when others are fearful and buy when others are selling.
"$IRE is our only long Irish bank stock," Rachel Kelly, president of Magnum Opus Financial said this afternoon, using Twitter lingo. "Hoping for a $C-like survival."
-- Written by Lauren Tara LaCapra in New York
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