The Warning o' the Ratings

Ireland's credit downgrade and the cost of bailouts.

| From today's Wall Street Journal Europe.

Dublin got a wake-up call this week when Standard & Poor's downgraded Ireland's sovereign credit rating yet again. Look and learn.

The government has fallen to double-A from double-A-plus, its second downgrade in three months. And S&P warned more rating cuts could come as strains on the government purse grow. This tracks similar moves by Moody's and Fitch.

Ireland isn't alone. Spain and Greece have been downgraded, and S&P warned recently that it could cut Britain's rating too. Ratings agencies are hardly perfect arbiters of risk. But Ireland's example still offers some important broader lessons.

The first lies in the dangers of government largesse during boom times. Ireland's looming fiscal deficit underlies the rating decisions. Government expenditures rose by 138% in nominal terms over the past decade, a time when the economy itself grew "only" 72%, according to Constantin Gurdgiev of Dublin's Trinity College. Much of that spending went to social programs and civil servant salaries. Combine those commitments with a tax base reliant on the bubble-prone property sector, and Ireland faced a 12.75% deficit this year before a new budget trimmed that to a still whopping 10.75%.

Which brings us to the other lesson, on the dangers of overly hasty government intervention even amid a financial crisis. Dublin is still reeling from its decision last year to guarantee €440 billion ($616 billion) in bank deposits and debts -- a sum equal to more than double Ireland's GDP. Since no one knows if or how much or when taxpayers might have to spend under that plan, the guarantee hangs like a cloud over the government. Dublin in January also nationalized Anglo Irish Bank, meaning that the lender's losses are now the taxpayers' problem. A wider-than-expected loss of €3.8 billion at Anglo Irish for the previous six months, announced in late May, helped spur S&P to action this week.

These crisis-response moves have eliminated any wiggle room Dublin might have had to solve its other economic problems. For instance, where will it find another €55 billion to €75 billion to fund the "bad bank" it is proposing to rescue lenders? S&P raised that issue in its downgrade report.

Now Dublin faces the political headache of bringing order to its books, a task complicated by the fact that social programs and bureaucrat pay are among the hardest budget lines for any government to cut. The government of Prime Minister Brian Cowen is doing it in the worst possible way: increasing taxes (on salaries, and the VAT) in a recession. Which means the Irish will pay twice, both to the tax man and in the form of lower economic growth.

Irish policy makers know how to spur an economy. Witness the country's low corporate tax rates, which fueled foreign investment and economic growth and transformed Ireland into the Celtic Tiger. But Dublin squandered a good part of that advantage by making unsustainable spending promises in the fat years. The aftermath is a political problem at home, and a cautionary tale for leaders elsewhere.