DUBLIN, Ireland - November 10, 2010 - With doubts swirling about the solvency of the Irish state in early September, Finance Minister Brian Lenihan summoned a dozen senior government and bank officials to a conference room nicknamed the "torture chamber," a nod to its history as a venue for painful meetings.

For two years, Ireland had poured money on a raging banking crisis, to no avail. Each estimate of the rising price of rescuing Ireland's banks turned out too low. Mr. Lenihan needed to halt the drip-drip of bad news that was leading his country to ruin. "I want a final figure ASAP," he told the group.

Two weeks later, the estimate came in: Up to €50 billion - nearly $50,000 for every household in the Emerald Isle.

But now, investors are betting the bill could be higher still and could reignite Europe's sovereign-debt crisis. The unpopular government is bracing for collapse, and on Tuesday, Irish government bonds continued a weeklong slide to a fresh record low. The debt is judged as risky as Greece's was this spring just before that nation begged for a European Union bailout.

Mr. Lenihan, racing to ease those fears, proposed Thursday shrinking the country's 2011 budget by €6 billion. Proportionally, that's as if the U.S. suddenly eliminated the Defense Department.

Ireland's troubles are Europe's. The 16 euro-zone countries have agreed to guarantee up to €440 billion in loans if any among them is unable to borrow from private markets.

It wasn't supposed to be this way. In October 2008, Mr. Lenihan boasted that his government had devised "the cheapest bailout in the world so far." Ireland's financial regulator pronounced the banks "more than adequately capitalized."

Interviews with dozens of bank and government officials, and an examination of documents released by the Irish parliament, reveal that Ireland misjudged its crisis early on. Desperate to preserve the homegrown banking system, the government - blind to just how sour Irish loans had gone - yoked the fate of the nation to the fate of its banks.