In a last-ditch effort to preserve the euro and stem a broader financial panic, European leaders agreed Thursday to reduce Greece’s debt burden . The pact, negotiated in Brussels, is part of a rescue package of 109 billion euros, or $157 billion, for Greece, the most troubled economy in the euro zone. It will force many investors in Greek debt to accept some losses on their bonds.
This deal will also provide substantial debt relief for Ireland and Portugal. And by giving the main European rescue fund increased powers to assist countries that have not been bailed out(for example Spain and Italy) leaders are betting that the program will serve as a firebreak against the contagion that has threatened to engulf some of the region’s largest economies.
Officials have shunned for some time variants that would force banks and other creditors share some losses on Greek debt. But European leaders are taking the calculated risk that they can avoid spooking investors by expanding the aid package to include other troubled countries on Europe’s periphery.
The fear consisted in the Greece failure to pay its debt in full, which could lead to panicked selling of other European bonds. That could make it impossible for other countries to borrow at a reasonable interest rate and finance themselves.
The lack of a solution to Greece had also frightened financial markets. This forced European leaders to act this week. On the eve of the summit meeting, Nicolas Sarkozy of France and Angela Merkel of Germany met in Berlin, along with the president of the European Central Bank. They came to an agreement that euro zone taxpayers would have to cover the rescue costs to preserve the integrity of the single European currency. But it is not clear now how German and French citizens will react to the proposal is unclear.
Financial markets in Europe and the United States rallied Thursday on news that a broad agreement was imminent, one that would end the piecemeal approach that has brought only temporary relief in the last couple of years. Most economists had deemed Greece incapable of repaying its debt mountain.
According to the plan, Greece would receive assistance in several ways. Holders of short-term obligations would be able to swap their notes for debt with longer maturities and backed by high-rated bonds. An organization that includes most major European banks said its members would accept the offer and expected 90 percent of all Greek bonds to be exchanged. Officials said that the terms of the aid package from Europe to Greece would be eased, with maturities lengthened to 15 years from 7.5 years, at an interest rate of a quite low 3.5 percent.
The euro zone leaders would give wide-ranging new powers to the region’s rescue fund, the European Financial Stability Facility, by allowing it to buy government bonds on the secondary market and to help recapitalize banks — which might be needed when they write down the value of their Greek bonds.
The new powers would effectively turn the facility into a prototype European monetary fund — a move that has long been resisted by Germany, the euro zone’s richest nation, but that has drawn the support of economists and government officials outside Europe.
Together, the various measures are intended to show that the euro zone’s leaders are committed to taking forceful policy measures — just as the United States and Britain did during the 2008 crisis — that will stem the spread of contagion.
Peter Bofinger, an economist in Germany who is a member of an economic panel that advises the German government, said: “This is a move in the right direction. The important thing is that they have agreed on a more flexible role for the E.F.S.F. — that should help in reducing tensions.”
But the true test will most likely come in the months ahead, when nations like Portugal, Ireland and Spain, which are struggling to impose unpopular austerity measures on their people, confront the difficulty of cutting budget deficits in the face of brutal recessions.While the agreement to increase the powers of the euro bailout fund did not come easily, the debt deal was perhaps harder to secure. The move will be deemed a selective default by the credit ratings agencies, something the European Central Bank had previously said was unacceptable.
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. Germany has opposed this. [Photo via Steffen Kugler; via The New York Times and Reuters]