By James G. Neuger – Oct 14, 2011
European officials are considering writedowns of as much as 50 percent on Greek bonds, a backstop for banks and continued central bank bond purchases as key planks in a revamped strategy to combat the debt crisis, people familiar with the discussions said.
The Greek bond losses may be accompanied by a pledge to rule out debt restructurings in other countries that received bailouts, such as Portugal, to persuade investors that Europe has mastered the crisis, said the people, who declined to be identified because the negotiations will run for another week.
In the works is a five-point plan foreseeing a solution for Greece, bolstering of the European Financial Stability Facility rescue fund, fresh capital for banks, a new push to boost competitiveness and consideration of European treaty amendments to tighten economic management.
Political, technical and legal constraints cloud the crisis-resolution strategy, due to be hammered out at an emergency Oct. 23 euro-area summit in Brussels under mounting pressure from markets and politicians around the world.
The strategy hinges on putting Greece on a viable path, as two years of austerity plunge it deeper into recession and provoke civil unrest that threatens the country’s political stability. Greece forecasts its debt to reach 172 percent of gross domestic product in 2012 as the economy shrinks for a fifth year.
Options include tweaking a July accord struck with investors for a 21 percent net-present-value reduction in Greek debt holdings. One variant would take that reduction up to 50 percent, the people said.
Under a more aggressive proposal, investors would exchange Greek bonds for new debt at a lower face value collateralized by the euro-area’s AAA rated rescue fund, the people said. The ultimate option is a restructuring involving writedowns without collateral, they said.
The bank-aid model under discussion is to set up a European-level backstop capitalized by the EFSF rescue fund, the people said. It would have the power to take direct equity stakes in banks and provide guarantees on bank liabilities.
Such ideas are controversial in Germany, Europe’s dominant economy, which so far has called for bank recapitalization on a country-by-country basis.
Officials are considering seven ways of getting more firepower out of the temporary rescue fund. The options break down into two broad categories: enabling it to borrow from the European Central Bank or using it to provide bond insurance.
The ECB has all but ruled out the first method, making bond insurance more likely, the people said. Recourse to that method would imply that the central bank would need to maintain its secondary-market purchases for an unspecified “interim” period, the people said. ECB President Jean-Claude Trichet has expressed reluctance to maintain the purchases.
The Frankfurt-based ECB has bought 163 billion euros ($226 billion) of bonds, overriding opposition from Germans on its policy council. The purchases started with Greece, Ireland and Portugal and widened to Italy and Spain in August as those markets came under attack.
A consensus is also emerging to speed up the setup of a permanent aid fund planned for July 2013, the European Stability Mechanism. Next week’s discussions will focus on creating it a year earlier, in July 2012, and easing unanimity rules that permit solitary countries to block bailouts.
One proposal is to enable aid to go ahead when backed by countries representing 95 percent of the fund’s capital on the basis of an assessment by the European Commission and ECB, the people said. Another proposal would set an 85 percent threshold.
Revisions to the voting rules would prevent local politics in smaller countries from stopping aid measures deemed necessary by Germany and France. Slovakia, for example, stayed out of Greece’s first aid package, and Finland spent three months negotiating a tailor-made collateral arrangement as its price for contributing to the next one.
Greece’s plight and dwindling investor confidence in the bonds of Italy, the world’s fourth-largest debtor, have triggered a reconsideration of bondholder loss-sharing provisions as part of the permanent fund, the people said.
Germany was the main driver behind the provisions for “private sector involvement.” The July accord on a second Greek bailout threw that into question by declaring Greece’s case “exceptional and unique.”