Pressure for Deal at Thursday Summit Berlin Working on Plans for Greek Debt Cut

The leaders of the euro zone are becoming convinced that the only way to save Greece is to restructure its growing mountain of debt. The only remaining question is how. The German Finance Ministry is analyzing a number of options, including the EU rescue fund purchasing Greek debt.

The flags of the EU and Greece in front of the Acropolis. EU officials are realizing that a debt cut may be the only way to rescue Greece.

The flags of the EU and Greece in front of the Acropolis. EU officials are realizing that a debt cut may be the only way to rescue Greece.

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The appeal was a dramatic one, but the situation warranted it. "The current mood is not helping us pull ourselves out of the crisis," Greek Prime Minister Giorgios Papandreou said in an interview with the Financial Times Deutschland published last Thursday "This insecurity frightens off investors."

Papandreou is undoubtedly right. As his country stands dangerously close to national bankruptcy, finance ministers from the 17 euro-zone countries remain divided on how to organize a second bailout package for Greece.

Still, last Monday, they at least agreed on one thing: that, so far, all rescue efforts aimed at buying Greece some time to gain some control over its debt problems had failed. Indeed, Greece's economy is on the verge of collapse, and its skyrocketing debt level has now reached 150 percent of GDP.

As a result, politicians are starting to arrive at the same conclusion that economists made long ago: Greece can only be helped with a debt "haircut." But that's where the problems start. How should a buyback of Greek sovereign bonds be organized? And what role should private creditors, such as banks and insurance companies, play in it?

German Officials Seeking 'Fundamental Solution'

Officials in Germany's Finance Ministry are analyzing several models for paring down Greece's debt burden to a more tolerable size. They are aiming to reduce its debt to about 120 percent of GDP. In absolute terms, this would involve relieving the country of roughly €70 billion ($99 billion) in debt. "We are searching through our entire arsenal for a fundamental solution to the problem," said one official close to Finance Minister Wolfgang Schäuble.

The basic version of such a solution would be to have the European Financial Stability Facility (EFSF) -- the European rescue fund -- purchase Greek sovereign bonds from banks and insurance companies that want to unload them. As an alternative, the fund could exchange Greek bonds for European ones.

The problem with this is that at present, the EFSF's rules don't allow these kinds of operations. They could be amended, of course, but not without resistance. In Germany, the business-friendly Free Democratic Party (FDP), the junior partner in the ruling coalition, is leading the fight in parliament against allowing the rescue fund to buy up bonds on the secondary market.

The second model tries to get around this constraint by allowing the EFSF to give Greece the money it needs to buy back its own bonds. Since its bonds are currently trading at only half their nominal value at most, this would be a good deal for Greece.

Such an offer might be very attractive for creditors, too. Many of them only stocked up on Greek sovereign bonds after the crisis, when they were already being traded at below face value. Other creditors, such as financial institutions, have already written down their Greek bonds and have them on their books at low market value. If the Greeks offer more than market value, it might be worth it for such companies to sell their bonds.

Since it is purely voluntary and tax-funded, this model would be far removed from the real private-sector participation that the German government has been calling for. But finance officials still believe this program could reduce Greek debt by up to €20 billion. The model would require a slight rise in the planned €120 billion volume of the second Greek aid package, but it would not require an increase in the overall EFSF rescue fund.

Not Enough Support For Debt Rescheduling

In early June, Schäuble was still backing a third and completely different model for tackling the problem: gently rescheduling the debts. This model envisions extending the maturity period of all bonds in the hands of private creditors by seven years. But it doesn't have majority support in the EU.

There even less backing for tougher debt rescheduling models, such as one proposed by Martin Blessing, the head of Commerzbank, Germany's second-largest bank. In a guest editorial for Frankfurter Allgemeine Zeitung last week, he called on creditors to forgive part of the debt and to allow the remainder to be converted into bonds with longer maturities, largely guaranteed by the euro zone.

On Monday, Die Welt newspaper reported that euro governments were considering imposing a bank levy as a way to force banks to contribute to a Greek rescue. Citing unnamed diplomats, Die Welt said such a move could enable Greece to avoid being categorized as a credit default case by ratings agencies. However, it is unclear whether a bank tax would be politically acceptable because it would hit all banks, regardless of whether they held Greece bonds or not.

Employees of the EU and the Institute of International Finance (IIF), the international banking association, are currently meeting in Rome with a number of major players to discuss what a restructuring of Greek debt could look like. These include executives from major banks -- such as HSBC, BNP Paribas and Deutsche Bank, the largest banks in the UK, France and Germany, respectively -- as well as representatives of Allianz, the Munich-based insurance giant. The teams of experts are also trying to figure out which banks could take over responsibility for conducting this complicated deal.

Detailed proposals could be ready by mid-August. But one stumbling block continues to be the potential reaction of the ratings agencies. They oppose any substantive participation by private creditors and are threatening to treat it as a de facto default.

Despite this threat, there is growing willingness in Germany's Finance Ministry to take this risk and to lock horns with the European Central Bank (ECB) -- if this ratings downgrade is short term. The reasoning behind this is the belief that such a restructuring would put Greece on a better footing no matter what, thereby obliging the ratings agencies to award it a better rating.

A number of financial institutions also reached a consensus on this issue long ago: As they see it, things can't go on as they have been, and the only way to get past the Greek problem is with an all-around solution that deals with the whole mountain of debt.

At the moment, Europe's banks are under a lot of pressure. Eight of them failed a stress test conducted last Friday. And, fearing a spread of the euro crisis, American lenders are increasingly unwilling to supply European financial institutions with dollars via short-term debt instruments. In fact, in only four weeks, the amount of foreign money market securities held by American banks has dropped by $23 billion, to $230 billion.

Euro-zone heads of state and government will meet in Brussels on Thursday for an emergency summit on this issue. But it's still unclear whether they will be able to agree on a solution. The Germans, in particular, have resisted this kind of summit for a long time, arguing that they only wanted to hold one when there was a decision on the table.

But, on Friday evening, European Council President Herman van Rompuy got his wish and scheduled the emergency summit. It might not get European leaders to agree on a solution, but it will at least put more pressure on them to do so.

Translated from the German by Josh Ward


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