Will this week mark a turning-point in the sovereign debt crisis, with governments finally resolving to shift some of the pain of bank bailouts back to investors?

That’s the question investors are mulling as they watch how the Irish financial troubles are playing out.

Senior Irish cabinet ministers spent yesterday hammering out the winding-up details for debt-ridden Anglo Irish Bank, which has now been nationalised.

The final decision, due to be released on Thursday, is expected to include a plan for restructuring the bank’s bonds.

And here the Irish government faces a tricky dilemma. If the bank’s bondholders are forced to share in the pain, the Irish government will alleviate some of its intense budgetary strains.

At the same time, the decision could spell problems for other Irish banks, which need to raise about €25 billion ($US33.7 billion) this month to repay maturing debt.

In addition, a major debt restructuring could push Ireland’s cost of borrowing even higher. Last week, yields on Irish 10-year bonds soared to 6.6%, 4.3 percentage points more than benchmark German bunds on fears that Ireland would have to follow Greece in asking for a bailout from the European Union and the International Monetary Fund.

Against this, the Irish government has to weigh the real risk that the country’s finances will deteriorate badly if the Irish government commits to shielding the bondholders.

Despite prompt action in introducing three austerity budgets in the space of the past two years, Ireland is still facing a yawning budget deficit that stands at 11.6% of GDP. Irish government debt is expected to climb to close to 100% of GDP by 2012, compared with 25% before the onset of the financial crisis.

Many blame the Irish government’s decision to extend a two-year blanket guarantee to cover all the deposits and debt liabilities for the country’s current financial woes. The Irish government’s losses on Anglo Irish Bank are now estimated at $33.7 billion — or close to $7550 for every man, woman and child in the country.

The Irish government has promised to continue supporting Anglo Irish depositors, but Irish media reports last week suggested that the riskiest lenders to Anglo Irish — the holders of the country’s $2.3 billion in subordinated bonds — will not get all their money back.

These bonds are currently trading at less than one-third of their face value. If the Irish government decides to conduct a buyback of these bonds at that rate, it will reduce the exposure of Irish taxpayers’ exposure to the bank by more than $1.6 billion.

At this stage, the Irish government looks as though it intends to treat the pay $5.7 billion of higher quality, senior bonds, differently and not force the holders of these bonds to take a haircut. The holders of these bonds are said to be British, German and French pension funds.

But some warn that Irish government doesn’t have the room to be so generous.

The Irish government was counting on an economic recovery to improve its budget outlook. But these hopes were crushed last week by figures that showed that the Irish economy shrank by 1.2% in the second quarter.

A sharp slowdown in the economy spells further problems for the banks’ loan books, as companies close down and lay off workers, and asset prices come under even more pressure. At the same time, rising unemployment means higher welfare payments at the same time as government revenues are under pressure from falling tax inflows.

As a result, the Irish government may be forced to implement even harsher austerity measures to reach its budgetary goals, which risks crippling the Irish economy even more.

Some believe the European Union may force Ireland’s hand. Any buyback of Anglo Irish bonds will have to be submitted to Brussels for approval.

The risk for investors is that Brussels sees this as an opportunity to impress on investors that they cannot rely on government bailouts, and they should be forced to share in the pain of bank losses. If Anglo Irish bond holders are forced to crystallise losses on their investments, their fate noted by other buyers of bank bonds.

Such a decision could create a renewed bout of uncertainly in European debt markets, and some European banks may temporarily find it difficult to access credit.

But these problems are not likely to be excessive, because the sums involved with Anglo Irish bonds are not large.

And Brussels may not be too averse to the idea of sparking a fresh outburst of tensions in European debt markets, particularly as it would likely stem the euro’s recent rise against the US dollar. And a lower euro is crucial for eurozone export strength.