"Bail-out 2.0" for Greece Set by Eurozone; Step Risks Temporary Default by Athens (7/21)     Print Email
By European Affairs

Leaders of the eurozone countries have agreed a new bailout package for Greece worth 109bn euros ($155bn). It includes, for the first time, support from private lenders, including banks, which will give Greece easier repayment terms.


The deal, struck at an emergency summit of the eurozone's 17 member countries, also involves support from the International Monetary Fund (IMF). Banks and other private investors will contribute 37bn euros to the package. French President Nicolas Sarkozy said private lenders will contribute a total of 135bn euros over 30 years to Greece.

Eurozone countries' leaders now seem willing to let Greece default on its debt under a crisis response that would involve a bond buyback and a debt swap (but no new tax on banks), according to several sources who spoke ahead of an emergency eurozone meeting about Greece on July 21 in Brussels. News reports quoted a draft document allowing this momentous shift in EU policy on Greek debt, but said that it remained unclear whether leaders would actually approve this plan.

The breakthrough deal could provide the basis for broad flexibility and economic support on the part of the EU in helping sustain not only Greece but also other indebted countries such as Ireland and Portugal. Significantly, the eurozone bailout fund – the European Financial Stability Facility (E.F.S.F) – will be able to provide loans to these countries at a lower interest rate and for longer maturities. E.F.S.F loans reportedly would be extended from 7.5 years to at least 15 years and the interest rate will be lowered from around 4.5 percent currently, in the case of Greece and Portugal, to around 3.5 percent. The euro rose on the report.

"Private creditor participation in Greece's latest rescue programme will be very strictly limited to the Greek crisis and will be specifically excluded as a model for any other eurozo country in financial difficulties, according to officials closely involved in the eurozone negotiations in Brussels," the Financial Times reports.

Here is a quick analysis of the implications of a Greek default on the country’s debt.

The New York Times reported developments in a similar way: “Eurozone leaders are set to agree on a series of measures to lighten the burden on Greece, Ireland and Portugal – all of which have been forced to seek international aid. Such an agreement would mark a significant shift of direction and a recognition that the mountain of debt hanging over those countries threatens to stifle any prospect of recovery for their economies. More significantly, the eurozone leaders were also being asked to give wide-ranging new powers to the region’s bailout fund, the European Financial Stability Facility, by allowing it to buy government bonds on the secondary market and to help recapitalize banks where necessary. That would effectively turn the E.F.S.F. into a prototype European monetary fund.” (The same breakthrough was forecast by the EUObserver, which said that eurozone leaders "look set to greenlight a new loan for Greece as well as establish what will effectively be a European Monetary Fund.")

Such sweeping commitments were rejected by Germany only months ago. Now,  strengthening the bailout fund signals a new willingness in Berlin and other EU capitals to come to terms with the scale of the eurozone’s debt crisis by taking a big step toward common economic structures. The challenges for Greece and the other bailed-out countries remain enormous, however, and some fear a default may still happen, even though markets reacted positively Thursday.

This scenario fits the recommendations for saving the euro made yesterday in the U.S. by Nouriel Roubini, a U.S. economist who has won high regard for his insights during the financial and economic crises affecting both the U.S. and the EU. His recommendation centers on a bond swap to ease Greece's plight: that would trigger "a credit event" (in effect, a temporary selective default), but Roubini said that the damage would be short-lived if European leaders handle the crisis skilfully now.

The possibility of a default emerged from a mix of new options that has emerged in how to give Greece a second bail-out but also shifts part of the costs to creditor banks. Debt-rating agencies earlier indicated that much-discussed plans for voluntary-based private bondholders’ acceptance of easier conditions for Greece would amount to a default.

An earlier proposal – for a bank tax – was reportedly taken off the table as the meeting started by its main proponent, French President Nicolas Sarkozy. His shift would allow German Chancellor Angela Merkel to push through an initiative for more direct measures to get private bondholders to help pay for the bail-out – a significant advantage for her in dealing with domestic opposition to more financial aid to Greece at no cost to the creditors who bought the Greek debt.

The Brussels meeting is increasingly seen as the most important in the history of the euro. Quick action has been urged by the International Monetary Fund and apparently, too, by President Barack Obama, who phoned Merkel on July 19. He had already urged Germany to be more forthcoming toward Greece in an earlier phase of the Greek crisis.

Other options for private sector involvement believed to be on the table include a range of options for private bondholders to contribute. But there is reportedly no “take-it-or-leave-it” approach in the discussions – beyond an apparent consensus that the Greek situation has become unsustainable without some relief from the country’s crushing debt load.

The ideas being floated seem designed to help Berlin (and others such as the Dutch government) ward off public opposition to more help for Greece by shifting part of the burden to creditor banks.

Doubts about the “contagion risk” of a Greek default have been strong at the European Central Bank, but its head, Jean-Claude Trichet, was reportedly persuaded – in talks late Wednesday with Sarkozy and Merkel – that special arrangements could be made for Greece that would allow the ECB to keep Greek banking liquid despite a default.


-- By European Affairs