Europe agrees sweeping new powers for rescue fund
Euro zone leaders agreed at an emergency summit on Thursday to give their financial rescue fund sweeping new powers to help Greece overcome its debt crisis and prevent market instability from spreading through the region.
French President Nicolas Sarkozy said leaders of the 17-nation currency area had agreed to ease lending terms to Greece, Ireland and Portugal, while private investors would voluntarily swap their Greek bonds for longer maturities at lower interest rates to help Athens.
Acknowledging that the rescue package might lead credit rating agencies to declare Greek debt in limited default—the first such event in the euro's 12-year history—Sarkozy said euro zone nations stood ready to protect Greek banks from the fallout, by providing credit guarantees if needed to ensure the banks can still obtain liquidity from the European Central Bank.
"We have agreed to create the beginnings of a European Monetary Fund," Sarkozy told a news conference after eight hours of talks on widening the remit of the rescue fund, the European Financial Stability Facility.
European Council President Herman van Rompuy, who chaired the fifth summit on the crisis since February, said the leaders agreed the EFSF would be allowed to buy bonds in the secondary market if the ECB deemed that necessary to fight the crisis.
The EFSF would also be allowed for the first time to give states precautionary credit lines before they were shut out of credit markets, and lend governments money to recapitalise banks—both moves which Germany blocked earlier this year.
The expanded role of the EFSF is designed to prevent bigger euro zone states such as Spain and Italy from being shut out of the markets in the event of a Greek default.
Earlier, the ECB signalled in a policy reversal that it was willing to let Greece default temporarily as part of the plan, which involves longer and cheaper emergency loans to the euro zone's three bailout states, a debt swap and a bond buyback. A proposal to raise money for Greece by imposing a new tax on banks was rejected.
The summit accord was based on a common position crafted by German Chancellor Angela Merkel and Sarkozy in late night talks in Berlin on Wednesday with ECB President Jean-Claude Trichet.
Dutch Finance Minister Jan Kees de Jager said a short-term "selective default" for Greece, long vehemently opposed by the ECB, was now a possibility.
"The demand to prevent a selective default has been removed," he told the Dutch parliament.
Maturities on euro zone rescue loans to all three bailout countries will be extended to 15 years from 7.5 and the interest rate cut to around 3.5 percent from 4.5-5.8 percent now.
The EFSF's wider powers could help minimise any market contagion in case of a temporary Greek default, but analysts said it remained to be seen whether the relatively modest debt relief achieved by the package would be sufficient.
Sarkozy said the private sector involvement would reduce Greece's debt by 12 percentage points of Gross Domestic Product. But since the debt mountain already stands at about 150 percent of GDP, the relief hardly looks like a game-changer.
In an apparent trade-off for Merkel's new willingness to embrace new powers for the EFSF, Sarkozy agreed that private sector bondholders should take a hit and dropped a French call for a tax on banks to help fund a second Greek bailout.
The leaders also promised a "Marshall Plan" of European public investment to help revive the Greek economy, in a deep recession due to draconian austerity imposed by the European Union and the International Monetary Fund.
The euro and European stocks, which had fallen on talk of a selective default, rallied sharply on news of the emerging deal. The Stoxx European banking index closed up 4.1 percent and the insurance index gained 3.0 percent. Italian and Spanish shares rose strongly.
The risk premiums which investors demand to hold peripheral euro zone government bonds rather than benchmark German Bunds fell to two-week lows as expectations of a bolder-than-expected Brussels deal took hold.
"It really shows, in the 11th hour, leadership from the euro zone leaders," said Niels From, chief analyst at Nordea.
But Win Thin, global head of emerging markets strategy at Brown Brothers Harriman in New York said: "This is really just kicking the can down the road.
"These countries need a serious hard restructuring. I do not think this is going away, and debt swaps rarely work."
The 109 billion euro second Greek rescue package will involve more official funding from the EFSF and the IMF Fund, in addition to the contribution by private sector bondholders and Greek privatisation revenues.
Greek Prime Minister George Papandreou said the package created a sustainable debt path for his country and sent a very strong message of support for Greek banks, which have been bleeding deposits all year.
Senior bankers were present in the corridors of the summit but not at the table, officials said. They included Baudouin Prot of BNP Paribas, the foreign bank with the biggest exposure to Greek debt, and Deutsche Bank chief executive Josef Ackermann, chairman of the International Institute of Finance, which drafted proposals for private sector involvement. Top Greek bankers were also present.
The IIF proposed a "voluntary" exchange of Greek debt maturing until the end of 2019 for 30-year paper and forecast a 90 percent take-up rate. Several sources said the resulting net contribution of 17 billion euros would mean a write-down of about 20 percent on the value of banks' Greek bond holdings.
The new bailout, likely to be formally concluded in September, will supplement a 110 billion euro ($156 billion US) rescue plan for Greece launched in May last year.
Worried about the impact on financial markets and wary of angering their own taxpayers, euro zone governments had struggled for weeks to agree on major aspects of the plan, especially the contribution by private sector investors.
New IMF Managing Director Christine Lagarde attended the summit but the leaders did not heed the global lender's call for the EFSF to be boosted in size from 440 billion euros.
The expansion of the EFSF's role will have to be endorsed by national parliaments, but diplomats said critical lawmakers in Germany, the Netherlands and Finland are likely to back it since the private sector will be sharing the burden.
Even so, Thursday's summit is unlikely to mark a complete resolution of the crisis, as Merkel herself acknowledged earlier this week.
A second bailout may simply keep Greece afloat for a number of months before a tougher decision has to be made on writing off more of its debt.
Many economists believe the only way out of the euro zone's debt crisis in the long run may be closer integration of national fiscal policies—for example, a joint euro zone guarantee for countries' bonds, or issuance of a joint euro zone bond to finance all countries.