VIENNA, Feb 3 (Reuters) - Austria should at least consider allowing troubled lender Hypo Alpe Adria to go bust, a prominent economist said on Monday, opposing the official line in an increasingly heated debate about how to handle the nationalised bank.
The government, central bank and a special Hypo task force have warned that a Hypo insolvency might trigger a chain reaction that could suck in other banks and ruin Austria's reputation on international capital markets.
Austria took over Hypo in 2009 after the bank's breakneck expansion pushed it to the brink of bankruptcy. Taxpayers have provided 4.8 billion euros in aid for Hypo so far.
The coalition wants healthier commercial lenders to support a "bad bank" that would absorb toxic assets from Hypo. Other banks have been sceptical about taking part unless they stand to benefit.
Opposition parties want the government to debate the option of insolvency.
Karl Aiginger, head of the WIFO think tank whose economic forecasts help shape government policy, told reporters it was short-sighted for officials to reject the insolvency route out of hand.
"We have to look at this solution. It is absolutely unintelligent to rule out this solution," he said in response to a question.
But he added that any such step had to be accompanied by measures to avoid any potential "snowball effect".
While he did not go into detail, these steps may include state support for Hypo's home province of Carinthia, which can not afford to make good on over 12 billion euros ($16 billion) in outstanding guarantees on Hypo debt.
The federal government would also need to guarantee around 1.5 billion euros in covered bonds, backed mutually by provincial mortgage banks, the Kurier newspaper has reported.
On the other hand, taxpayers could save billions if Hypo creditors including bondholders and former owner BayernLB had to take "haircuts" on their claims on Hypo.
Austria is at loggerheads with BayernLB - majority owner of Hypo before the 2009 rescue - alleging that the Bavarian bank misled it over the severity of Hypo's problems.
"To say no (to insolvency) from the start means that the Bavarians will certainly not contribute," Aiginger said.
The debate in Austria mirrors a wider move in the European Union, whose blueprint to close failing banks depends on a 'resolution' fund into which banks are to pay roughly 55 billion euros over 10 years.
$1 = 0.7415 euros editing by Jane Baird