Ireland will take majority control of Allied Irish Banks and pump billions more into two smaller banks, driving the deficit to record levels and requiring more austerity measures, the government announced Thursday.
Finance Minister Brian Lenihan said the latest figures were "horrendous but manageable," and promised there would be no default on the banks' massive debt.
He said Ireland's deficit this year would likely shoot past 30 percent of gross domestic product to account for the unexpectedly high bill to save the three banks, which also include Anglo Irish and Irish Nationwide.
Lenihan said the government would pump 3 billion euros ($4.1 billion) more into Allied Irish, once the country's largest bank, and take majority control. The government already is the bank's biggest shareholder following previous rounds of aid. Allied Irish shares plunged more than 20 percent on the news.
The Central Bank, meanwhile, forecast that the total bailout bill at nationalized Anglo Irish Bank would be 29.3 billion euros ($40 billion). Ireland already has committed 22.9 billion euros and is splitting the Dublin lender into a deposit bank and a toxic loan management bank.
The Central Bank warned that, under "a severe hypothetical stress scenario," the long-term Anglo bailout bill could top 34 billion euros. The bank said this worst-case scenario would involve the bank's loans on property-based assets failing to recover 65 percent of their original value by 2020.
Lenihan said Ireland also would inject another 2.7 billion euros into another small nationalized lender, Irish Nationwide, doubling the bailout bill there. Irish Nationwide is expected to be sold to foreign investors or merged with one of Ireland's two remaining healthy banks, Bank of Ireland or Irish Life & Permanent.
With nearly 12 billion euros total extra state funds now headed to the banks — and European Union rules requiring the spending to be added to the annual deficit — Ireland's 2010 deficit could reach 32 percent, a post-war high in Europe.
Lenihan said Ireland must accept an even more severe 2011 budget than previously signaled. The Irish already have imposed three emergency budgets since 2008 that have raised taxes and cut wages across this country of 4.5 million, and the budget to be unveiled Dec. 7 was expected to involve 3 billion euros more in cuts.
But Lenihan said Ireland could not afford to trim its expenses, particularly at Anglo, by requiring senior bondholders of the banks to eat some of their losses. Ireland has stuck doggedly since 2008 to the view that the top foreign investors in Ireland must be insured against losses, because defaulting would spook investors.
"This is a country which is highly dependent on international investment," Lenihan said.
However, he said the government would negotiate cut-rate settlements with Anglo's most junior holders of "subordinated" bonds with a face value of 2.4 billion euros. This could reduce Ireland's estimated 29.3 billion euro price tag by a billion or two.
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