EU Said to Consider 50% Greek Writedown

By James G. Neuger - Oct 15, 2011 12:00 AM GMT+0700

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 current problems of the euro zone have all the elements of a classical tragedy: a brave and exciting hero launches into the world, but is marred by fatal flaws,” David Beim, a professor at Columbia Business School in New York, said in an e-mailed research paper. “Only radical action could save the common currency.”

French Bonds Slump

The crisis raged today through France, the 17-nation euro area’s second-largest economy and co-anchor with Germany of the European Union. French bonds slumped, pushing the 10-year yield up 17 basis points to 3.13 percent. The week’s rise of 38 basis points was the most since the euro’s debut in 1999.

European officials will discuss the evolving strategy at this weekend’s Group of 20 meeting in Paris with global financial leaders including U.S. Treasury Secretary Timothy Geithner, who has criticized Europe for indecisiveness. While Europe is weighing a “much more forceful package,” Geithner said on CNBC today that “the hard part is still ahead.”

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 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.

Debt Exchanges

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 constraint is how to cut Greece’s debt without leading rating companies to declare the country in default. Such a “credit event” triggered by a forced restructuring could unleash a cascade of losses through markets.

“Now is not the time for speculation, now is the time for action,” German Finance Minister Wolfgang Schaeuble told reporters today in Paris.

The bank-aid model under discussion is to set up a European-level backstop capitalized by the 440 billion-euro ($609 billion) 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.

Capital Level

French Finance Minister Francois Baroin said on Europe 1 radio today that it may be “good” to force banks to maintain a 9 percent capital buffer to absorb sovereign risks, up from the 5 percent core capital level used in July’s stress tests.

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. EFSF guarantees of new bonds sold by distressed euro-area governments might range from 20 percent to 30 percent, a person familiar with those deliberations said.

‘Leverage Effects’

“We must optimize the efficiency by leverage effects,” European Commission President Jose Barroso said today in Saint- Cyr-sur-Loire, France.

Recourse to bond insurance suggests the central bank will need to maintain its secondary-market purchases for an unspecified “interim” period, the people said. ECB President Jean-Claude Trichet, whose eight-year term ends Oct. 31, has expressed reluctance to maintain the policy.

The Frankfurt-based ECB has bought 163 billion euros 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 accelerate 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 proceed when backed by countries representing 95 percent of the fund’s capital on the basis of an assessment by the EU and ECB, the people said. Another proposal would set an 85 percent threshold.

Dodging Politics

Revisions to the voting rules would prevent local politics in smaller countries from stopping measures deemed necessary by Germany and France. Slovakia, for example, stayed out of Greece’s first aid package. 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.”

A leading opponent of further bondholder losses is Ireland, aiming to return to market financing by the end of 2012 after receiving 67.5 billion euros in aid last year.

It is “perfectly clear” that bondholder burden-sharing “is an issue of concern not only to Ireland but to other countries,” Irish Prime Minister Enda Kenny said in Brussels yesterday.

To contact the reporter on this story: James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net