The euro crisis

The euro crisis

A substantial problem

by Charlemagne | BRUSSELS

AS ministers, officials and journalists stagger out of the Justus Lipsius building tonight, the unofficial word is that European leaders will be summoned here on Friday to finalise the deal that finance ministers could not conclude.

The statement issued last night was a study in vagueness (see my earlier post), but the outlines of a compromise are becoming clearer: in exchange for a willingness by private bond-holders to support some form of debt rollover for Greece, euro-area members will have to support Greece in buying back its bonds from the secondary market.

The basis for this deal is the position taken by the banks, as set out by the Institute of International Finance, which said “it would be important to consider possible debt buyback proposals, which could, along with further fiscal adjustment, begin to reduce the stock of debt and help pave the way toward improved debt sustainability.”

The idea of allowing the main European bail-out fund, the European Financial Stability Facility, to buy bonds on the secondary market—whether directly or, more likely, by lending money to Greece to do it—was ruled out earlier this year. But now it is at the heart of the package deal to be discussed by leaders.

Yet although the principle of such a compromise has been hinted at, the details are yet to be worked out. How much finance can be raised “voluntarily” from the private sector? The Netherlands, in particular, insists the contribution must be “substantial”, even at the cost of having the move labelled a “selective default” by credit-rating agencies. The European Central Bank is adamantly opposed to this, and the numbers so far have been unimpressive.

And how much debt needs to be bought back to make a real impact on Greece’s burden? Diplomats say the numbers start at €60 billion ($84 billion) and go up. And if Greece gets extra money to buy up its loans, Ireland and Portugal will ask the same.

In other words, the amount raised from the private sector may turn out to be insubstantial. And though buying bonds at a discount will crystallise the losses of those who sell them, the money paid to private bond-holders is likely to be substantial indeed.

On Friday, the day leaders are expected to meet, the European Banking Authority will publish the results of its latest bank stress-tests. Many question the credibility of the tests, particularly whether they fully reflect the danger of sovereign-debt default. But German banks, in particular, say (paywall) they are worried that the revelations will open them up to attack in the markets. European finance ministers said today that transparency about the state of the banks will reduce nervousness in the market, and promised to take any "remedial action" needed to strengthen banks found to be vulnerable.

European policy is thus oddly discordant: on the one hand finance ministers want financial institutions to take a hit over Greece; on the other they are preparing to shore up financial institutions weakened by, among other things, the Greek crisis. Jacek Rostowski, the Polish finance minister who holds the rotating EU presidency, says there is no contradiction: the two policies involve different banks. The proposition is about to be tested.