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ECB-German Standoff Risks Damage That May Force Compromise

ECB, Germany May Be Forced to Compromise
While the ECB has said it could accept a plan in which creditors voluntarily agree to buy Greek bonds to replace maturing debt, Trichet said last week the ECB has no intention of rolling over its own Greek holdings. Photographer: Kostas Tsironis/Bloomberg

The confrontation between the European Central Bank and Germany over bailing out Greece risks causing so much damage that officials may be forced to compromise.

“The balance of forces in the euro zone is a little like it was in the Cold War: both sides are brandishing deterrents that would be too horrendous to use,” said Philip Whyte, a senior research fellow at the Centre for European Reform in London. “It’s all going to turn on whether you can fiddle with debt maturities without calling it a credit event.”

ECB President Jean-Claude Trichet and German Finance Minister Wolfgang Schaeuble are at odds over investors’ role in the second Greek rescue in 14 months. The dispute turns on how politicians make good on a promise to push creditors to pay some of the cost, a step that Trichet said on June 9 could be an “enormous mistake.”

Unless a deal can be struck to guarantee Greece’s financing needs for the next 12 months, the International Monetary Fund has threatened to withhold its share of what remains of Greece’s original 110 billion-euro ($159 billion) bailout. Finance ministers have called a special meeting tomorrow as they try to avoid what European Economic and Monetary Affairs Commissioner Olli Rehn called a “Lehman Brothers catastrophe on European soil.”

The cost to insure Greek debt against default, already the most expensive in the world, rose to a record today and bonds of Europe’s bailed-out nations slumped. The swaps indicate a 74 percent chance of default in the next five years.

Giving Ground

“Somebody has to concede ground over the coming days or the region will experience a full-blown financial crisis,” JP Morgan Chase & Co. economists led by Bruce Kasman, the firm’s New York-based chief economist, wrote in a June 10 report. ‘Our inclination is to think that the German government will back down and that the region will reach an agreement on a financing package that will include some modest, voluntary private-sector involvement.”

The debt crisis has already forced Trichet to tear up the rule book. The ECB is lending unlimited amounts of cash to support banking systems and has relaxed collateral requirements. In May 2010, it took the unprecedented decision to start buying the bonds of distressed nations in an effort to calm markets as Greece’s fiscal woes began to infect other euro-area members.

The Frankfurt-based central bank has since bought about 75 billion euros of bonds. Of that, 40 billion euros is Greek debt, according to a Barclays Capital estimate. The ECB stopped buying bonds 10 weeks ago.

Voluntary Plan

While the ECB has said it could accept a plan in which creditors voluntarily agree to buy Greek bonds to replace maturing debt, Trichet said last week the ECB has no intention of rolling over its own Greek holdings.

He also warned against Schaeuble’s proposal that maturities on Greek debt be extended for seven years, an outcome that credit-rating companies said would be considered a default. That in turn could cut off ECB lending to Greek banks, setting off a chain reaction.

Asked about the possibility of a Greek default at an event in London today, the ECB president said the central bank’s advice is to “avoid what would be a compulsory concept.”

“It has to be, in our opinion, a voluntary concept,” Trichet said at the London School of Economics. “Avoid whatever would trigger a credit event, avoid whatever would trigger a selective default or a default.”

“This is as simple as that. This is our message to governments,” he said.

Greek Yields

Turning up the pressure on politicians, Bundesbank President Jens Weidmann said the euro can withstand a default.

“The euro would even in this case remain stable,” he told German newspaper Welt am Sonntag yesterday.

The euro added 0.4 percent to $1.4399 as of 3:36 p.m. in London as yields on two-year Greek notes rose above 26 percent for the first time in three weeks. CDS prices jumped 21 basis points to 1,584, according to CMA.

The yield difference, or spread, between 10-year German bunds and Greek securities of a similar maturity rose 28 basis points to a record 1,404 basis points today.

Politicians are trying to reach agreement on a new aid package by a European Union summit on June 23-24.

European governments and the IMF would lend as much as an extra 45 billion euros to Greece under a new bailout plan that also includes roughly 30 billion euros in asset-sale proceeds and about 30 billion euros in rollovers by creditors, two people with direct knowledge of the talks said last week.

Debt Rollovers

“Participation of private creditors in cases of insolvency is indispensable,” Schaeuble told lawmakers in Berlin June 10. A working group set up last week is charged with identifying “a good solution for the involvement of the private sector that can and has to be supported by the European Central Bank,” he said.

While the ECB is prohibited by its founding treaty from buying bonds on the primary market, Deutsche Bank economist Gilles Moec said it could encourage debt rollovers by restarting its secondary-market purchases. Some strategists say the ECB doesn’t have much debt to roll over out of Greece’s total of about 330 billion euros.

“My understanding is the ECB hasn’t bought a great deal of those Greek bonds that are going to be the primary targets,” Vincent Chaigneau, head of interest-rate strategy at Societe Generale SA in London, said an interview. “If the ECB doesn’t participate it won’t be that big a problem. I tend to believe the governments can pressure the banks, either with positive or negative incentives.”

Incentives being considered include giving investors preferred status, higher coupon payments or collateral, said people familiar with the matter who declined to be identified because the talks are in progress.

“If it comes to turmoil in the market, the ECB will probably resume their government bond purchases and keep the banks topped up with liquidity,” said Marco Valli, chief euro-area economist at UniCredit Group in Milan. “But that is as far as they will go.”

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