comprehensive solution

Calling Bankers’ Bluff, Merkel Got Europe a Debt Plan

It was approaching 2 a.m. Thursday, not long before the Asian markets would open, and the two leaders were desperately trying to nail down the last component of a complex deal to save the euro: forcing the banks to pay a greater share of Greece’s effective default.

For hours, negotiators had been trying to persuade the banks to accede to a “voluntary” 50 percent loss in the face value of their Greek bond holdings. The banks, which had already agreed to a 21 percent write-down, had dug in their heels.

They knew how badly the European leaders needed a deal, and how much financial experts feared a disorderly, involuntary default. That could set off a “credit event,” throwing world financial markets into turmoil, much as the collapse of Lehman Brothers did in the fall of 2008.

But Mrs. Merkel called the bankers’ bluff, said officials present at the discussions. Accept the 50 percent write-down, she told the bankers, or bear the consequences of default. In effect, she was willing to risk a credit event, and to place the blame for any fallout on them.

The European success sent the markets soaring and laid out the path to a more comprehensive solution to the euro crisis, though the plan faces hurdles.

It includes an order to weak banks to raise more capital to protect against bad loans, and an effort — still very vague — to increase the firepower of the $625 billion bailout fund, the European Financial Stability Facility, to better protect large and vulnerable economies like Spain and Italy.

But the very process of achieving those steps underscored the many problems that lie ahead for the euro zone. While the rescue package has been hailed as an important step, it was achieved only under enormous pressure from the financial markets and with a steely, last-minute stand by Mrs. Merkel.

Foremost among those problems is Italy, which is too big to bail out, owing a total of $2.7 trillion, or 120 percent of its gross domestic product. While Italy runs a relatively small budget deficit, Prime Minister Silvio Berlusconi’s government seems paralyzed, vowing structural changes to produce growth and to further shrink public spending, but it is so far too weak and divided to deliver on most of its promises.

Italian news outlets reported on Thursday that a number of lawmakers from Mr. Berlusconi’s coalition had signed a letter asking him to stand down to allow for the creation of a government that could pass the measures that would tranquilize jittery financial markets.

Market skepticism about Italy has led to high interest rates on its bonds, which if unchecked could rip huge holes into its budget and possibly provoke a full-blown credit crisis. With Mr. Berlusconi hanging on by a thread, and his coalition partner, Umberto Bossi of the Northern League, working to block fundamental change, Italy remains a major vulnerability in restoring market confidence to the euro.

European leaders Thursday welcomed new promises made by Mr. Berlusconi, including a weak pledge to increase the age for pensions to 67 from 65 by the year 2026, but said sternly that carrying them out was the key.

Along with the European Central Bank, they have demanded such changes in return for buying up Italian bonds at cheaper than market rates and helping to create the bailout fund, and now to expand it to about $1.4 trillion, because at $625 billion it is far too small to protect Italy or Spain, and nearly half of that is already committed.

But the leaders were vague about how to enlarge the fund, and reluctant to put up more of their own nations’ capital. They said they hoped to create another special fund open to investment by China, Russia and Japan — which all expressed a willingness to help in principle — as well as by other wealthy nations with surplus cash. But how such a fund would work, and what guarantees it would provide to investors, remain to be determined next month, European officials said. Until the details are clear, there is likely to be little investment.

Also left unclear are the details of how to leverage the existing fund, by guaranteeing a percentage of potential losses by bondholders. While Mr. Sarkozy said the aim was to leverage the fund up to $1.4 trillion, there was no agreement on the specific percentage the fund would guarantee. More should become clear by the time of the Group of 20 summit meeting on Nov. 3 and 4 in Cannes, France.

Liz Alderman contributed reporting from Paris, and Elisabetta Povoledo from Rome.

Article source: http://www.nytimes.com/2011/10/28/world/europe/europe-in-accord-on-basics-of-plan-to-save-the-euro.html?partner=rss&emc=rss

Europeans Report Progress on Bank Rescue Plan

After negotiating through the weekend in Brussels in search of a comprehensive solution to the Continent’s sovereign debt crisis, European leaders reported progress on the framework of a broad rescue package.

If, as the leaders have pledged, the final details are announced when the summit meeting wraps up on Wednesday, it could quell the worst fears of investors by taking the risk of a financial collapse off the table.

But if the talks break down, some investors said Wall Street might need to brace for a repeat of the turmoil that followed the Lehman Brothers’ downfall in 2008.

“If Wednesday comes and there’s no real progress, we’ll see a riot in the markets,” said Mark D. Luschini, the chief investment strategist at Janney Montgomery Scott. “We need at least some broad schematics.”

European officials appeared to reach an agreement on Sunday evening that the size of the bank recapitalization plan would be about 100 billion euros ($138 billion).

But more has yet to be decided. Officials still had no final answer on how they might increase the firepower of a separate euro zone rescue fund known as the European Financial Stability Facility. Nor had they reached agreement on how steep the write-offs would be that holders of Greek debt might be required to take.

Expectations among investors have been modest. Many said they were not necessarily expecting to see a detailed solution come out of the meeting, but hoped to see signs of significant progress.

“I think we will get something; it will probably be half-baked and it will probably give us two to three months of room to figure out the next steps,” said Jaime Valdivia, head of global emerging markets research and strategy at BlueCrest Capital. “If we get something mediocre out of the euro zone, markets can climb higher because the expectations have been so low.”

Even as European officials suggested that $138 billion would help the banks shore up their balance sheets, investors were still trying to assess the severity of the banks’ problems.

There are doubts that $138 billion will be enough to cushion the blow from big losses on Greek debt and that of other fiscally troubled European nations.

In July, banks and other institutional investors agreed to take losses of about 21 percent on Greek debt.

But as Greece’s economy has deteriorated, some policy makers are now suggesting that banks will need to take much bigger losses, perhaps as much as 60 percent.

Greater clarity about the extent of the problem could remove some of the fear hanging over the markets, many investors said.

“There are rumors flying all over the place on how big the recapitalization needs to be — from 100 billion to 400 billion euros,” said Christopher Orndorff, who helps oversee global fixed-income investments at Western Asset Management.

“I think the number that they come out with needs to be a credible number,” he added.

Milton Ezrati, a senior economist at Lord Abbett Company, said, “Even if they say the losses are going to be a larger number, at least people would know where the line is.”

Since the summer, the markets have swung wildly with each burst of news from the Continent. As reports emerged last week that European officials were nearing a deal on a rescue plan, the Standard Poor’s 500-stock index rose 1 percent.

Asian markets rose on Monday morning, but that was partly a result of a report showing that Japan’s exports had increased more than expected. The Nikkei 225 in Tokyo was up 1.5 percent, while the S. P./ASX 200 index was up 2 percent.

Even if the recapitalization plan is seen as credible, there is still the question of whether the banks will be able to raise money without disrupting the markets.

The plan under discussion calls for banks to turn to private investors before tapping government-backed funds.

A similar arrangement was used successfully in the United States after stress tests in 2009. There is concern that European banks may find it difficult to raise capital from private investors and instead start selling assets and spark a fire sale.

“The global economy could take another hit,” Mr. Valdivia said.

Julie Creswell and Graham Bowley contributed reporting.

Article source: http://feeds.nytimes.com/click.phdo?i=39a7f279f2df0134fd3d6eb5bcdb2f2b

Calling Bankers’ Bluff, Merkel Got Europe a Debt Plan

Europeans Report Progress on Bank Rescue Plan

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