Eurozone wins respite, but it could be brief

[October 28, 2011]  FRANKFURT, Germany (AP) -- With their late-night deal to cut Greece's debt and support other wobbly countries, European leaders bought time to work out more lasting solutions to the crisis plaguing the euro currency bloc. What they do with that time will determine whether this summit succeeds where many others have failed.

Thursday's three-pronged deal at long last appears to have met or beaten expectations for some kind of decisive action, judging by stock market rallies in Europe and around the world. It retools the eurozone's underpowered bailout fund, calls on banks to take 50 percent losses on Greek bonds and orders them to raise euro106 billion in new capital by June.

"The summit is likely to be the corner from where the odds start to change in the right direction," said Erik Nielsen, global chief economist at Unicredit.

But European leaders will have to work out the complex financial details quickly and skillfully. It's unclear whether the bailout fund changes will be enough to prop up Italian and Spanish banks, or whether the bond writedown will be enough to pull Greece from the brink.

Along with that, countries with sluggish economies, particularly Italy, will have to show that they are becoming better places to do business and improving growth -- the key to paying down debt in the long run.

So the debt crisis is still far from over. But with luck the eurozone's 17 governments might get a chance to work on it for a while without fear that a single misstep will take the shared currency over the edge.

The respite could be short if they return to the fudges and procrastination that have so far marked their response to the crisis, which broke out just over two years ago when Greece admitted to the EU statistics agency that its finances were much worse than reported.

Since then, more than a dozen late-night summits and carefully negotiated and crafted statements have failed to get ahead of market fears that Greece would default on its debts and sink the banking system and the wider economy. The crisis also took down Ireland and Portugal, which like Greece were forced to take a bailout because they couldn't borrow affordably and faced default on maturing bonds.

The hope now is that the trio of measures crafted in Brussels on Wednesday and Thursday will give European countries some breathing space within which to focus on getting their economies growing again. That would help reduce debt and boost confidence in the region's financial markets and banking sectors, reversing what had threatened to be a downward spiral.

The most difficult part of the plan was persuading banks to take 50 percent losses on their Greek bonds to make the country's debt pile small enough for Greece to be capable of repaying it. But even that massive "haircut" might not be enough.

The deal will cut Greek debt to 120 percent of economic output by 2020, from 180 percent otherwise. Yet debt of more than 100 percent of GDP is still breathtakingly high.

European leaders agreed to push Europe's banks to raise euro106 billion in new capital by June, to protect against losses from the Greek debt writedown. The money will come from governments if it can't be raised from investors or by selling assets.

The euro440 billion ($610 billion) bailout fund -- the European Financial Stability Facility -- will be reworked to make its firepower equivalent to around euro1 trillion ($1.39 trillion), to make it better able to help large but wobbly countries such as Italy and Spain.

The EFSF will insure part of the potential losses on the debt of those countries, to relieve fears of default and lower the interest rate investors want. The spiraling cost of borrowing was what sank smaller Greece, Ireland and Portugal.

Eurozone finance ministers are to work out the terms of the scheme in November, but there are already doubts about how leveraging the bailout fund's limited resources will work.

Joerg Kraemer, the chief economist at Commerzbank, said it was not at all clear that such a guarantee -- which essentially admits there are fears of default -- will appeal to government bond investors, who typically want safe investments.

And the "voluntary" Greek writedown pushed on banks might convince some potential bond buyers that if there's more trouble, they'll be asked to pony up instead of being compensated through the EFSF's insurance program.

If the EFSF plan isn't enough to magnify its power, wealthier governments such as Germany, France and the Netherlands may have to put more money into it. But with bailouts unpopular in the countries funding them, governments will resist unless the fate of the euro appears once again at stake -- meaning back to the brink.

"This alone suggests that the sovereign debt crisis will continue to become exacerbated before ebbing off," said Kraemer.

It's also not clear how long the European Central Bank will continue key purchases of government bonds, keeping borrowing costs down. The EFSF has the power to do that, but skimpy resources, economists say.

There is always the danger that governments will not properly implement the reforms they have promised. That has been a sticking point with Greece, which has been reluctant to cut jobs in the public sector, and promises to be an issue in other countries, like Italy, where labor unions are powerful.

Longer-term forces also are making recovery more difficult for the eurozone's weakest members. Large trade imbalances remain, meaning big surpluses in countries like Germany will create deficits in importing countries like Greece. Without the safety valve of shifting exchange rates, that is unlikely to change soon.

Despite the host of questions, markets cheered the European leaders' plan. Stocks surged 5 percent in France and 4.7 percent in Germany, the euro's core where banks are heavily exposed. Indexes in London and New York also rose substantially.

"Market participants in the U.S. and London are weary of eurozone problems," wrote Stephen Lewis at Monument Securities in London. "They would have been satisfied with any statement on debt that had enough substance to allow them to move on to fresh themes."

Lewis said Thursday's agreement "fits that bill and buys eurozone leaders more time."

How they use that time is now very much the question.

[Associated Press; By DAVID McHUGH]

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