Q&A: Why Ireland is in trouble

The boom of the Celtic tiger has been followed by public sector salary cuts and unemployment at 14%. How did it all go wrong?
Ballymun estate in Dublin
Children playing outside a makeshift shop in Ballymun, a former black spot of North Dublin. Photograph: Kim Haughton/The Guardian KIM HAUGHTON/The Guardian

Ireland's borrowing costs are being pushed to unsustainable levels. The interest the government needs to pay to borrow from the international markets to fund public spending rose yesterday for a 13th consecutive day, to 9.07%. No government can afford to finance itself at this rate – meaning the country may be forced into a Greek-style bailout from the EU or IMF.

Why is Ireland in trouble?

The Irish real estate bubble, the product of a decade of ample and cheap credit, burst last year. Irish banks had lent freely, almost without considering the risk that people and companies might not be able to pay back their loans. As a result they have needed multibillion-euro taxpayer-funded cash injections to survive, pushing up the government's deficit.

Why do bond investors penalise the deficit?

International lenders want reassurance that a borrower will pay them back, and that the borrower will have a top rating. A big deficit increases the risk that a country may not be able to meet its interest payments, so investors sell the bonds, pushing up the yield, which moves in the opposite direction to the price.

What is a bond yield?

It is the cost of borrowing – the interest companies and governments pay to borrow from international markets.

What are "the markets"?

Global markets are formed by thousands of traders, banks, pension funds and other investors, which buy stocks and bonds, amongst other assets. The world's biggest bond investors include US asset management firms such as Blackrock and Pimco.

Why aren't investors more patient with struggling countries?

They are in the market to make money. Bill Gross, head of the world's biggest bond fund, told the Guardian in an interview earlier this year that his clients did not pay him to feel sorry for companies or countries. But he said he would vote for leftwing governments – including Britain's Labour – as they would tone down the severity of budget cuts.

Who are the Bond vigilantes?

They are activist bond investors who pressure governments, such as Greece, Ireland, Portugal, Spain or Britain, into draconian budget cuts to make sure they will get their money back.

Why are the Bond vigilantes more powerful than governments?

Because together, they have more money than any single government. Governments have mostly lost every battle against the market – including Britain's exit from the EMU in 1992, which earned millions for investors such as George Soros.

Why has this turbulence happened this week?

Investors have watched Ireland very closely for months, but concerns were heightened this week after French and German officials said bondholders should share any losses linked to a potential sovereign debt restructuring. Until now investors and governments operated on the basis that the EU would guarantee the interest payments of any EU country.

Politicians are now saying investors must also suffer if there are losses – and this has scared investors. The London-based clearing house LCH.Clearnet also contributed to this week's sell-off by announcing clients had to pay more to trade Irish bonds, given the increased risk of a restructuring.

Why would Ireland need a bailout if it has said it is fully funded until next year?

Such high interest rates severely jeopardise private Irish companies' access to the financial markets, and also put big pressure on the country's credit rating. The whole country suffers from this lack of investor confidence.

What would a bailout look like?

Greece, which unlike Ireland needed immediate cash to pay investors, is able to borrow from the EU's emergency fund at 5%, much lower than the more than 10% that markets charge the country. The bailout has offered lower financing costs, but has also put the country through a stringent deficit-cutting regime.

Can Ireland do anything to regain the markets' confidence?

Investors say the country is now at the mercy of bondholders because if they announce further budget cuts the economy will sink into a new recession. That would hit tax revenues, lifting the deficit again.

Are the Bond vigilantes the new masters of the universe?

At this point, yes. They have forced extremely painful austerity measures on Greece, Spain, Britain, Portugal and Ireland.