Bloomberg News

EU Tackles Crisis With 50% Greek Writedown, $1.4 Trillion Fund

November 02, 2011

(For more on the European debt crisis, see EXT4.)

Oct. 27 (Bloomberg) -- European leaders cajoled bondholders into accepting 50 percent writedowns on Greek debt and boosted their rescue fund’s capacity to 1 trillion euros ($1.4 trillion) in a crisis-fighting package intended to shield the euro area.

The 17-nation euro and stocks climbed while bond spreads narrowed after leaders emerged early today from a 10-hour summit in Brussels armed with a plan they said points the way out of the quagmire, albeit with some details still to be ironed out.

“Overall the outcome is better than we anticipated one week ago,” Laurent Bilke, global head of inflation strategy at Nomura International Plc in London, said in an interview. “There are several issues left open, but I do believe that getting a more necessary debt relief for Greece is a pretty important step.”

Last-ditch talks with bank representatives led to the debt- relief accord, in an effort to quarantine Greece and prevent speculation against Italy and France from ravaging the euro zone and wreaking global economic havoc. Greek Prime Minister George Papandreou will address the nation at 8 p.m. in Athens to outline the summit’s ramifications for the country at the eye of the two-year sovereign debt crisis.

“The world’s attention was on these talks,” German Chancellor Angela Merkel told reporters in Brussels at about 4:15 a.m. “We Europeans showed tonight that we reached the right conclusions.”

ECB Role

Measures include recapitalization of European banks, a potentially bigger role for the International Monetary Fund, a commitment from Italy to do more to reduce its debt and a signal from leaders that the European Central Bank will maintain bond purchases in the secondary market.

The euro advanced to a seven-week high against the dollar, rising above $1.40 for the first time since September. It was at $1.4007 at 11:48 a.m. in Brussels. The Stoxx Europe 600 Index surged 2.6 percent.

“It’s long on words, short on detail,” said Peter Dixon, an economist at Commerzbank AG in London. “The solution that’s been put in place now gives us enough ammunition to stave off any immediate problems but we may well run into other problems down the track.”

The summit was the 14th in the 21 months since Europe pledged solidarity with Greece, and came amid mounting global pressure for the bloc to deliver a credible anti-crisis toolkit before a Group of 20 meeting Nov. 3-4 in Cannes, France.

Banks Summoned

Europe’s leaders took the unusual step of summoning the banks’ representative, Managing Director Charles Dallara of the Institute of International Finance, into the summit to break the deadlock over how to cut Greece’s debt to 120 percent of gross domestic product by 2020 from a forecast of about 170 percent next year.

Dallara squared off with a group led by Merkel and French President Nicolas Sarkozy around midnight after issuing an e- mailed statement that “there is no agreement on any element of a deal.”

Sarkozy said the bankers were escorted in “not to negotiate, but to inform them on decisions taken by the 17 and then they themselves went on to think and work on it.” Luxembourg Prime Minister Jean-Claude Juncker said the banks’ resistance was broken by a threat “to move toward a scenario of total insolvency of Greece, which would have cost states a lot of money and which would have ruined the banks.”

Insolvency Threat

The resulting “voluntary” losses by bondholders were the key plank in a second bailout for Greece, which was awarded 110 billion euros in May 2010 at the outbreak of the crisis. The new program includes 130 billion euros of official aid, up from 109 billion euros envisioned in July.

The Washington-based IMF, meanwhile, said it is ready to disburse its 2.2 billion-euro share of the next installment of Greece’s original bailout. The release of the euro zone’s 5.8 billion-euro share was approved last week.

Greek, Spanish, Italian and French bonds all rallied today, with the spreads over benchmark German bunds narrowing. The yield on German 10-year bonds jumped eight basis points, the most in more than 11 weeks, to 2.11 percent at 10:05 a.m. London

The yield on Greek bonds due in October 2022 fell 117 basis points to 24.15 percent, Spanish 10-year yields dropped 16 basis points to 5.32 percent and Italy’s 10-year bonds advanced for a second day, with yields falling 13 basis points to 5.81 percent.

ECB President Jean-Claude Trichet, who has warned against the spillover effects of bond writedowns on the banking system, didn’t take part in the confrontation with bankers on the debt relief. He later praised the leaders’ determination to get ahead of the crisis.

Trichet’s Call

The measures agreed “have to be fully implemented, as rapidly and effectively as possible,” Trichet, who leaves office Oct. 31, said afterwards.

Leaders tiptoed around the politically independent ECB’s broader role in keeping the euro sound, making no mention of its bond-purchase program in a 15-page statement. The Frankfurt- based central bank has bought 169.5 billion euros in bonds so far, starting with Greece, Ireland and Portugal last year, then extending the coverage to Italy and Spain in August.

While Trichet didn’t mention the controversial purchases either, his successor, Mario Draghi of Italy, indicated that the policy will continue. Speaking in Rome yesterday, Draghi said the ECB remains “determined to avoid a poor functioning of monetary and financial markets.”

Leaders backed two ways of leveraging up the 440 billion- euro rescue fund, which was designed last year to shield smaller countries such as Greece, Ireland and Portugal, and lacks the heft to protect Italy, the euro area’s third-largest economy.

Leverage Options

Under plans to be spelled out in November, the fund will be used to insure bond sales and to create a special investment vehicle that would court outside money, from public and private financial institutions and investors.

Canadian Prime Minister Stephen Harper, speaking at a conference in Perth, Australia, called the agreement “grounds for cautious optimism,” and urged European leaders to work out details of the plan and implement it.

Europe cast about for more international money to aid the rescue, with France’s Sarkozy set to call Chinese leader Hu Jintao tomorrow with the goal of tapping into the world’s largest foreign exchange reserves.

While the mechanics are a work in progress, European Union President Herman Van Rompuy said the leverage effect would multiply the power of the fund by a factor of four to five. He compared it to normal banking business that needn’t entail excessive risks.

‘Detail Further’

“It will be important to detail further the modalities of how this enhanced EFSF will operate and deliver the scale of support envisaged,” IMF Managing Director Christine Lagarde said.

Europe also struck a bank-recapitalization accord, setting a June 30, 2012, deadline for lenders to reach core capital reserves of 9 percent after writing down their sovereign-debt holdings. Banks below that target would face “constraints” on paying dividends and awarding bonuses, a statement said.

The European Banking Authority estimated banks’ capital needs at 106 billion euros, with Spanish banks requiring 26.2 billion euros and Italian banks 14.8 billion euros. It gave them until Dec. 25 to submit money-raising plans to national supervisors.

Banks that fail to raise enough capital on the markets will first tap national governments, falling back on the EFSF rescue fund only as a last resort.

--With assistance from Helene Fouquet, Gonzalo Vina, Tony Czuczka, Ewa Krukowska, Jim Brunsden, Jonathan Stearns, Chiara Vasarri, Aaron Kirchfeld, Jurjen van de Pol and Angeline Benoit in Brussels, Lorenzo Totaro and Flavia Rotondi in Rome, Jason Scott in Perth, Maria Petrakis and Natalie Weeks in Athens, Lukanyo Mnyanda in Edinburgh and Jennifer Ryan and Scott Hamilton in London. Editors: James Hertling, Andrew Atkinson

To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; Stephanie Bodoni in Brussels at sbodoni@bloomberg.net

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


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