EU Officials Said to See Risks Amid Call for Debt-Swap Talks

Nicolas Sarkozy and Angela Merkel
France's president Nicolas Sarkozy and Germany's chancellor Angela Merkel. Photographer: Michele Tantussi/Bloomberg

European Union officials weighing deeper losses for Greek bondholders in a revamped bailout are concerned that any investor involvement risks further roiling markets, say people familiar with the EU’s deliberations.

Greece has accumulated at least 20 billion euros ($27 billion) in additional financing needs since a 159 billion-euro package was set in July, because of a deepening recession and delays in enacting the plan, said the people, who declined to be identified because euro-area leaders have yet to agree on their strategy.

French President Nicolas Sarkozy and German Chancellor Angela Merkel yesterday demanded “immediate talks” with investors to reduce Greece’s debt load. The EU is considering five scenarios, ranging from sticking with July’s voluntary swap to a so-called hard restructuring, where investors could be forced to exchange Greek bonds for new ones at 50 percent of their value, the people said.

Greek two-year notes currently trade at less than 40 percent of face value.

“Debt sustainability has effectively deteriorated, given delays in the recovery, in fiscal consolidation and in the privatization plan, as well as the perspective of bank recapitalizations,” according to a draft report by the European Commission, the European Central Bank and the International Monetary Fund, a group known as the troika.

Greek Writedowns

Further writedowns of Greek debt, which the government in Athens forecasts at 172 percent of gross domestic product next year, may be part of a strategy set at an Oct. 23 summit that includes a bank-recapitalization plan and an expansion of the euro’s 440 billion-euro rescue fund. Wrangling over the details forced the scheduling of another summit three days later.

Finance ministers, who kick off the marathon deliberations today in Brussels, are divided over how to increase the fund’s firepower. In Greece, Prime Minister George Papandreou won a parliamentary vote late yesterday on further austerity measures designed to secure more aid under the 2010 bailout.

European governments may unleash as much as 940 billion euros to fight the debt crisis, seeking to break a deadlock between Germany and France. Negotiations on combining the EU’s temporary and planned permanent rescue funds as of mid-2012, while scrapping a ceiling on bailout spending, accelerated this week after efforts to leverage the temporary fund ran into ECB opposition and provoked the French-German clash, two people familiar with the discussions said.

European Brinkmanship

Euro-area brinkmanship indicates a “risk that the post-summit announcements will suggest an ambitious program at a high level but lack concrete detail on implementation,” said Huw Pill, London-based chief European economist at Goldman Sachs Group Inc. “Given previous experience, markets are unlikely to be very tolerant of such an outcome.”

Officials are concerned that any kind of debt swap would worsen financing conditions for the other nations. This kind of contagion also adds pressure on non-Greek banks because of their exposure to this wider set of countries.

Banks are resisting taking losses deeper than those agreed to in July. That plan includes up to 35 billion in high-quality collateral for the investors, who would take a 21 percent reduction in their holdings’ net present value.

One option involves a swap with no collateral of any kind in the hard restructuring. Other plans involve an exchange with a 50 percent reduction in net present value, or upfront bond exchanges into either EFSF bonds or new 30-year Greek government debt, the people said. Upfront exchanges could involve a 50 percent discount off face value.

Remain Voluntary

Creditors’ participation needs to remain voluntary, Austrian Finance Minister Maria Fekter told reporters Oct. 18. “A forced restructuring means default, in which credit default swaps are triggered, and that means billions around the world that have to be financed,” she said. “Everybody wants to avoid that.”

The scenarios being discussed don’t specify how long the program will last and the pace of other elements of Greece’s rescue, like budget reforms and a privatization plan to raise money by selling state assets, the people said. Greek banks will need more capital under all scenarios, the people said.

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