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10/05/2011 05:26 PM

'Whole Set of Options'

IMF Offers to Dramatically Expand Euro-Zone Help

The International Monetary Fund on Wednesday indicated it was prepared to dramatically step up measures to help Europe combat the debt crisis, which threatens to spread to the Continent's banks. But the euro zone, the IMF said, needs to change its strategy.

With the Greek economy failing to recover to the degree expected, plenty of officials and analysts this week have fretted about whether efforts currently in place to prop up the country will be sufficient. On Wednesday, the International Monetary Fund joined the chorus, offering to vastly increase its role in helping the euro zone put the brakes on the accelerating debt crisis.

Speaking at a press conference in Brussels on Wednesday, Antonio Borges, head of the IMF's Europe program, said that the euro bailout fund, the European Financial Stability Facility (EFSF) needed to be significantly strengthened to prevent contagion from spreading to Italy and Spain. He also said that the second bailout package for Greece, a €109-billion fund agreed to by euro-zone countries in July, was far too small.

But Borges also indicated that the IMF was prepared to change its role in ongoing efforts to get Europe's debt crisis under control. The IMF, he said, could step in to bond markets to help prevent Spain and Italy from succumbing to the crisis.

"We have a whole set of options that could be put on the table to restore confidence in those countries," Borges said.

Strategy Shift

To date, the IMF has contributed some €80 billion to emergency funds to assist Greece, Portugal and Ireland, roughly one third of the total pledged to those three countries. Borges said on Wednesday, however, that the strategy needed to shift away from preventing insolvency and toward reducing Greece's vast mountain of debt and returning to growth.

Borges' comments came on a day when Greece ground to a standstill as a general strike gripped the country. Some 400 flights were cancelled at the Athens airport as airplanes remained grounded and trains across the country stopped running. Even as surveys have shown that a majority of Greeks support efforts to streamline the budget and cut spending, the country's two major labor unions, ADEDY and GSEE, called the strikes to protest the "unfair and barbaric policies which suck dry workers' rights and revenues and push the economy deeper into recession and debt," a GSEE spokesman told Reuters.

In addition to the public unrest in Greece, investors this week have been extremely uneasy about announcements over the weekend that Athens would miss budget deficit targets this year and next. In addition, Athens announced that its economy would shrink again this year instead of returning to growth as had been expected.

Combined with public officials now openly speaking about the possibility of a Greek insolvency, this led to plunging share prices earlier this week for European banks, particularly those which have significant holdings of Greek bonds. Indeed, French and Belgian officials continue struggling to come up with a plan to save Dexia Bank, which has wobbled significantly this week due to its heavy exposure to Greek debt.

Bank Worries

In a further sign of investor concern surrounding the Continent's banks, the iTraxx index, which monitors the price for Greek debt insurance, hit record highs in September, according to a report in the Financial Times. The index monitors prices for credit default swaps taken out on Greek debt -- the greater the chance of a Greek default, the higher the price. This week, the index shot up to levels well above where they were in the days following the 2008 failure of the investment bank Lehman Brothers.

European Commissioner for Economics and Monetary Affairs Olli Rehn on Tuesday evening sought to calm nerves in an interview with the Financial Times. He told the daily that "capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty." Markets took his comments to mean that the euro zone was working on a solution to recapitalize banks that are over-exposed to Greek bonds.

German Finance Minister Wolfgang Schäuble also said that his greatest worry at the moment is that "the disturbing developments on the financial markets could escalate into a banking crisis." He said that Germany could conceivably reactivate Soffin, the fund set up in the wake of Lehmann's collapse to prop up German banks. But a German government spokesman on Wednesday also said that banks in the country were in good shape.

Just how Europe intends to leverage the EFSF remains unclear. Several German officials have come out against proposals to enlarge the fund beyond its current €440-billion lending capacity. Indeed, that level of lending is still being approved by euro-zone parliaments this month, with Slovakia and Holland still set to vote.

cgh -- with wire reports

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