Irish plan may be only real EU money market salve

By Jamie McGeever - Analysis

LONDON (Reuters) - Ireland's effective underwriting of its entire banking system for two years has set a super-high bar for European Union-wide crisis coordination but it may now be the base line needed to restart frozen interbank money markets.

Dublin's unilateral step has been widely criticized for dramatically skewing the "level playing field" for intra-EU banking competition by lumping its taxpayer with potentially vast liabilities and protecting banks' shareholders.

But it has concentrated minds across the continent. Germany, Greece and Denmark have since indicated they will also guarantee depositors' cash, and the UK Treasury said it's prepared to take "radical" action if needed.

Yet the crucial difference that sets Ireland's plan apart is that its government not only guaranteed savers' deposits but also banks' wholesale liabilities.

That is to say, an institution lending to an Irish bank on interbank money markets now knows the borrower is good for the money because it has a government guarantee behind it.

And that difference is critical because the potential cost of effectively underwriting bank-to-bank lending compared with "just" retail deposits is incalculably higher.

Ireland has guaranteed some 400 billion euros ($550 billion) in total, just over double its entire annual economic output. Roughly half of the funds guaranteed are retail deposits.

If these figures are extrapolated across the EU, where total economic output last year was almost $17 trillion, it's easy to see the scale of the crisis.

The latest European Central Bank money supply figures showed all currency in circulation, overnight deposits, deposits of up to two years and other short-term deposits totaled almost 12 trillion euros.

The EU's political, tax and legal structures prevent a sweeping financial rescue package for the continent like the $700 billion bill likely to be passed in the United States.

But as the financial crisis deepens and broadens, the question facing Europe is less one of whether coordinated action at a regional level is needed, but how far coordination goes for limits on guarantees for bank depositors, recapitalization of battered banks and even wholesale banking exposure.

"What we need is targeted global money market action .... otherwise we could be facing financial and economic collapse," said Neil MacKinnon, chief economist at ECU Group, a London-based hedge fund.

"That may require governments effectively underwriting the interbank market in some shape or form, for a while, just to get banks lending again," he said.

SWEDISH TEMPLATE?

Credit markets have been in a deep freeze and financial markets of all hues in a state of flux in recent weeks since the collapse of U.S. investment bank Lehman Brothers pushed the 13-month long credit crisis into its darkest phase yet.