Like most banks, the Irish banks have been making money by giving long-term loans to customers at higher rates, and taking shorter-term loans from capital providers at lower rates. When times are good, capital providers are generous and indiscriminate. But in a recession, capital providers suddenly get choosy, and there is less money to go around.
It's a bit like the game musical chairs - at every round of negotiation the music stops, there is a scramble for insufficient resources, and one bank loses its position. The weakest bank in the group risks collapse if it can't get the next supply of short-term funds to fund the loans they have given out.
A government can use its strength and credibility to support its native banks with guarantees. That way the capital providers are less likely to get nervous. However, some of these loans are huge - bigger than even governments can manage. If the capital providers see that a government itself is at risk of default, then guarantees won't help, and the game is really up. Noboby wants to be the last capital provider left investing, and everybody pulls out - except the home government itself. The government effectively becomes 'as one' with its banks, as it is the only funder left.
In this way, the game of musical chairs can apply to governments. With each negotiating round, as funds become more scarce, capital providers progressively remove funding resources from the weakest countries. First Greece. Then Ireland. Then perhaps Portugal. Europe tries to mitigate this effect by providing 'support packages' - effectively, sharing the remaining chairs, somewhat uncomfortably.
Meanwhile, the original problem remains - long term loans being given out by banks, funded by short term loans from capital providers. This is a mismatch which will not leave us until banks learn to borrow, and lend, over matched periods.
Until this is done, capital providers are in the driving seat. And it may be that the only credible capital providers left will be governments, outside Europe, with access to high levels of sovereign wealth - some with an interest in political influence. Ironically, in Europe's quest to maintain control over its own banking system, the ultimate sacrifice may be some of Europe's political independence.
