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EU Hunts for Debt-Cut Tools in Overhaul to Tame Spreading Crisis

EU Hunts for Debt-Cut Tools in Overhaul to Tame Spreading
Left to right, Wolfgang Schaeuble, Germany's finance minister, Evangelos Venizelos, Greece's finance minister, Elena Salgado, Spain's finance minister, Jan Kees De Jager, the Netherlands' finance minister, and Giulio Tremonti, Italy's finance minister, chat during a meeting of the European Union finance ministers at the European Council headquarters in Brussels, Belgium, on July 11, 2011. Photographer: Jock Fistick/Bloomberg

European finance chiefs hunted for ways to cut Greece’s debt burden, floating ideas from bond buybacks to a temporary default in an overhaul of a strategy that has failed to contain the debt panic.

As a surge in bond yields in Italy and Spain brought the crisis closer to the heart of the euro area, Europe dusted off previously discarded plans under the glare of markets that have lost confidence in governments’ ability to still the turmoil.

“They are taking it one step a time and you never get ahead of the snowball,” said Matt King, Citigroup Inc.’s global credit strategy head in London. “You need a fundamental shift that deals with the whole crisis.”

The brainstorming at a two-day Brussels meeting whipsawed financial markets, sending 10-year Italian yields to a 14-year high before bonds recovered. The euro fell to a four-month low. Milan’s stock index dropped to its lowest in two years before rebounding.

Nine hours of talks yesterday yielded a six-paragraph statement in which the 17 euro governments pledged to flesh out a new master plan “shortly” to end the 21-month-old crisis, without setting a timeline. The meetings ended today with all 27 EU finance ministers plotting a response to the release of bank stress tests later this week.

The midnight declaration centered on Greece, “the core of the problem,” according to German Finance Minister Wolfgang Schaeuble. “The question of improving the debt sustainability in Greece is the solution to the crisis.”

Emergency Summit

European Union President Herman Van Rompuy considered convening an emergency summit of euro leaders, which would put the crisis management back in the hands of the government chiefs who first pulled Europe back from the brink by creating the bailout fund in May 2010.

The decision to have another look at reinforcing the 440 billion-euro ($618 billion) fund, beefed up only last month, came after talks with bondholders over a “voluntary” rollover of Greek debt ran into a threat by credit-rating companies to put Greece in default and opposition from the European Central Bank.

Prodded by the ECB, the euro’s guardians said the fund, known as the European Financial Stability Facility, may be used to buy bonds in the secondary market or enable Greece to retire its debt at a discount. They offered another cut in rates on its emergency loans.

Finance ministers gave themselves until late August to work out a second package for Greece to follow the 110 billion-euro lifeline extended in May 2010. Schaeuble said no extra aid will come about without an accord to keep bondholders exposed to the Greek market.

New Package

Greece’s next three-year package will also include lower interest rates and longer repayment times for official loans, the statement said. In a nod to demands by Finland and Slovakia, it said Greece might be required to put up collateral.

Finance ministers offered conflicting interpretations of the commitment to explore a wider range of options. Dutch Finance Minister Jan Kees de Jager, a Schaeuble ally, insisted on getting bondholders to roll over Greek debt even if that results in the “selective default” opposed by the ECB.

A “selective default” “is not excluded anymore,” De Jager said. “We have more options, a broader scope to work with.”

The statement didn’t foreclose that path, singling out the ECB as opposing a “credit event or selective default.” Schaeuble later insisted on a “voluntary” rollover and Luxembourg Finance Minister Luc Frieden said a brief phase of Greek non-payment is “not an option that we envisaged.”

Debt Buybacks

With Greek 10-year debt fetching less than 55 cents on the euro, buybacks were forced back onto the table by the Institute of International Finance, a group representing more than 400 banks and insurers that has tried to broker an accord on the French rollover proposal.

Rejected by Germany earlier this year, the buybacks would pare Greece’s debt burden of 142.8 percent of gross domestic product by enabling it to retire bonds at a discount. German resistance centered on using taxpayer money to help spendthrift countries wriggle out of their debt.

Italy, a focus of German concern in the 1990s runup to the euro with debt over 100 percent of GDP, returned to the forefront with a six-day bond plunge that ran out of momentum today. Italy now has Europe’s second-highest debt load, at 119 percent of GDP in 2010.

Italian Auction

Italy sold 6.75 billion euros of bills in its first auction since borrowing costs began soaring. The Treasury in Rome sold the one-year bills, meeting its target, at an average yield of 3.67 percent, up from 2.147 percent in the last sale on June 10.

Italian assets were upended by doubts whether Prime Minister Silvio Berlusconi, plumbing record-low approval ratings with two years left in office, will muster the strength to push through 40 billion euros in planned deficit-cuts.

“Euro-area financial markets will be caught in a tension between, on the one side, cheaper valuations and the knowledge that something is brewing, and on the other, nervousness for the lack of a coordinated final decision,” Francesco Garzarelli, Goldman Sachs Group Inc.’s London-based chief interest-rate strategist in London, wrote in a note today.

The bond rout also abated in Spain, the fourth-largest euro user, bringing yields off euro-era highs. Spanish 10-year yields fell 13 basis points to 5.90 percent, narrowing the spread over German debt to 322 basis points.

Spanish Prime Minister Jose Luis Rodriguez Zapatero lashed out at Europe’s “most powerful” countries for fumbling the crisis response. Speaking at Van Rompuy’s side in Madrid, he called on Europe’s leaders to “assume their responsibility.”

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