Heads of Europe Back Broad Plan to Rescue Greece

Pool photo by Steffen Kugler

From left, President Nicolas Sarkozy of France, Christine Lagarde, head of the I.M.F., and Chancellor Angela Merkel of Germany. 

By LANDON THOMAS Jr. and STEPHEN CASTLE

After years of resistance, European leaders agreed Thursday to reduce Greece’s debt burden in a last-ditch effort to preserve the euro and stem a broader financial panic.

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.
The deal would 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 — like Spain and Italy — leaders are betting that the program, described by some as a new Marshall Plan for Europe, will serve as a firebreak against the contagion that has threatened to engulf some of the region’s largest economies.
Officials have long shunned proposals that would make 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 had been that a failure by Greece to pay its debt in full 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 rattled financial markets, ultimately forcing 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, and came to a general agreement that euro zone taxpayers would have to cover the rescue costs to preserve the integrity of the single European currency. 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, which amounts to 150 percent of its gross domestic product.
Under 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.
Separately, 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.
“This is a move in the right direction,” said Peter Bofinger, an economist in Germany who is a member of an economic panel that advises the German government. “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. 
Jean-Claude Trichet, whose term as president of the European Central Bank will end in October, had argued forcefully that a Greek default, selective or otherwise, would cause contagion to spread as bondholders in other countries unloaded their Irish, Portuguese and even Spanish and Italian bonds.  

But as fears in Brussels mounted over a bond market rout in Italy — the euro zone’s third-largest economy — the risk seemed worth taking by many of Europe’s leaders.
Germany, which is paying the biggest portion of the bill to bail out Greece, has long pushed for a debt swap to keep bondholders committed to Greece with longer-term bonds.
Since 2009, foreign banks have reduced their Greek holdings to 45.5 billion euros from 68 billion euros, while taxpayers in Europe (with Germany way out in front) have seen their exposure to Greece go to $120 billion euros from zero — and that exposure is expected to grow.
And while bondholders will not need to take a big haircut now — an important element for capital-thin banks in France and Germany that are the biggest holders of Greek debt — they might certainly take one in the future.
“This will take maturing bonds out of the equation, and it keeps the bondholders in the game and ultimately will make them share in the pain,” said Lee C. Buchheit, a lawyer at Cleary Gottlieb Steen & Hamilton who has worked on similar debt deals in Latin America. “Everyone knows that something more drastic is coming, but when it comes, you want it to be the bondholders who pay, not the taxpayer.”
European officials said on Thursday that financial institutions that own Greek bonds would effectively contribute 54 billion euros through 2014, largely by accepting reduced interest payments, and will stretch their maturities to as long as 30 years.
In a statement, the Institute of International Finance, a bankers’ group, said that the deal would reduce Greece’s debt burden by 13.5 billion euros, and potentially more since the European rescue facility will be able to purchase bonds at a discount in the open market. That reduction is relatively small, though, relative to the country’s total debt of 350 billion euros, or $496 billion.
Still, the deal does represent the first concrete agreement between Greece and its bondholders, and its champions point to the success Uruguay had in 2003 when it initiated a similar program.
Critics have countered that Uruguay suffered from a short-term liquidity crisis, not a solvency problem rooted in a nearly bankrupt state, as is the case with Greece.
But the near collapse in Italian bonds last week pushed Europe to consider proposals that just months ago were unthinkable.
For example, a panel of German economists that advise the government last week recommended what economists call a hard restructuring of Greek debt, which would have resulted in an immediate 50 percent loss to bondholders. In the face of such a prospect, a maturity extension — and the risk that comes from being in selective default — may well be an acceptable alternative, for Europe, Greece and the bondholders themselves.