Bigger Losses Sought From Banks as Part of Euro Deal

by lexie Tue Oct 25, 2011 6:54 pm

October 25, 2011

Bigger Losses Sought From Banks as Part of Euro Deal

BRUSSELS — European officials scrambled Tuesday for a way to entice banks to accept much deeper losses on their Greek bonds as debt crisis talks went down to the wire, prompting the cancellation of one ministerial meeting scheduled ahead of Wednesday’s crucial gathering of European leaders.

John Kolesidis/Reuters
Prime Minister George Papandreou of Greece with reporters on Tuesday. European banks have been asked to write off more than half the value of Greek debt and agreement on this issue remains the key obstacle to a deal.
With less than 24 hours before the summit meeting of government chiefs in Brussels, banking representatives and European officials were locked in negotiation over what losses banks should accept.

The banks have taken a hard line and warned that the write-off of debts they are being asked to accept — of about 55 percent — could result in a default or similar shock to the financial system, something European officials are desperate to avert. That has prompted a search for so-called complementary measures which might help to sweeten the deal for the bankers.

Italy, meanwhile, has come increasingly under the spotlight as investors doubt the government’s commitment to reduce curb the country’s 1.9 trillion euro, or $2.6 trillion, debt.

European Union leaders want the Italian prime minister, Silvio Berlusconi, to present firm plans on growth and debt reduction in time for the meeting.

Italian news agencies reported late Tuesday that Mr. Berlusconi had reached an accord with the Northern League, his principal coalition partner. The league’s leader, Umberto Bossi, said earlier in the day that Mr. Berlusconi’s government could fall over the issue of raising the standard retirement age to 67 from 65, a move Mr. Bossi opposed.

With the clock ticking, a senior German official, Jörg Asmussen, and a French counterpart, Ramon Fernandez, joined intensive discussions with the banks in Brussels.

Under one of about five plans being debated, Greek bonds might be swapped for those of much lower face value issued by the euro zone’s bailout fund, according to two officials briefed on talks, who added that the idea might make a write-down more attractive for the banks.

The Institute of International Finance, which represents the banks involved, intends to send its own proposal to European leaders on Wednesday, according to a person with direct knowledge of the negotiations. That would involve banks taking more than the 21 percent loss they had agreed to in July, in exchange for sweeteners that would help mitigate some of the additional loss, such as allowing banks to buy bonds from the bailout fund.

“It’s clear that circumstances have changed too much for the July 21 agreement to work at this point,” said the person, who spoke on condition of anonymity because the discussions are ongoing. “We are prepared to adjust to new circumstances within limits. The question is are the governments prepared to meet us halfway.”

Adding to the mood of anxiety, a meeting of E.U. finance ministers on Wednesday, which was to precede the second gathering in a week of European leaders, was abruptly canceled on Tuesday by the Polish government, which holds the bloc’s rotating presidency.

Though that was a recognition that the deal with the banks will not be ready by Wednesday morning, it did not mean that agreement was impossible later in the day, when the leaders meet, diplomats and officials said.

The summit meeting will still take place and “work on the comprehensive package of measures to curb the sovereign debt crisis” will continue there, the Polish statement said.

Those measures include a recapitalization of European banks and an expansion of the firepower of the euro zone’s 440 billion euro bailout fund, probably to more than 1 trillion euros. This will likely be achieved through two methods that are likely to run alongside each other.

The rescue fund, known as the European Financial Stability Facility, is expected to offer insurance against a portion of the losses on bond purchases. A separate mechanism is expected to be set up to purchase bonds, drawing in funds from the International Monetary Fund and other investors from the emerging world.

Though France is reluctant to bring other powers, like China, into the heart of the euro zone, it will probably have to overcome its reservations because of the gravity of the situation.

Though officials expect the European Central Bank to play a role in bond buying, at least in the short term until a new system is established, Germany is resisting any firm reference by leaders to this as part of the deal.

In one vivid illustration of the urgent need for a deal, the Athens News Agency reported that from late August until the end of the first two weeks of October consumer deposits in Greek banks decreased by 4.9 percent, worth about 9.5 billion euros.

No package of proposals will add up unless the banks write down large amounts of debt, however.

“It is important to have clarity on private sector involvement,” Amadeu Altafaj Tardio, a European Commission spokesman on economic and monetary affairs, told reporters in Brussels, “all the issues are interlinked.”

The statement of the Polish presidency canceling the finance ministers’ meeting came just hours after an earlier declaration stating that it would go ahead, and increased the impression of confusion in European decision-making, sending stock markets and the euro lower.

Diplomats and officials said that the cancellation had less to do with the substance of the negotiations and more to do with internal politics of the 27-country Union, of which only 17 countries are members of the euro currency zone.

The ministerial meeting was intended to sign off a package of measures that are intertwined, but only some of them — most notably bank recapitalization — involve all 27 countries.

“It’s unfortunate handling by the Polish presidency, and bad news because the markets have tanked,” the diplomat said on condition of anonymity because of the sensitivity of the subject. But the diplomat said the summit meeting of leaders should not be affected.

The office of the German chancellor, Angela Merkel, said that her plans had not changed and that, after a speech to the Parliament at midday Wednesday, she would travel to Brussels for the summit meeting.

While political leaders fumbled toward a solution, analysts and bankers began to contemplate the consequences if there is an agreement to sharply cut the Greek debt load and require banks to raise their reserves.

A reduction of 50 percent to 60 percent in the value of Greek bonds would be hard to dress up as anything but a default, analysts said. The resulting “credit event” would activate insurance that investors have bought on Greek debt, known as credit-default swaps.

There is incomplete information on which banks may have issued the swaps and could be vulnerable to losses, creating an extra element of risk.

Among policy makers and analysts, there is palpable nervousness that there could be dire consequences that are impossible to predict.

“We have created a world that is non-computable because it is too complex,” said Fredmund Malik, chairman of Malik Management, a consultancy in St. Gallen, Switzerland.

Some consequences, though, are predictable.

Greek banks would require major aid to absorb the losses on their holdings of their government’s debt, which Barclays Capital estimates at 45 billion to 50 billion euros. The Greek banks would also need emergency cash to continue operating.

“Launching a hard restructuring without the adequate backstop could be too risky from a financial stability perspective,” Antonio Garcia Pascual, an analyst at Barclays Capital, wrote in a research report Tuesday.

There is also a question of what happens with the European Central Bank’s substantial holdings of Greek bonds, which have an estimated face value of about 45 billion euros. Jean-Claude Trichet, president of the E.C.B., has said that the central bank would not participate in any voluntary debt relief for Greece, known as “private sector involvement,” because it is not part of the private sector.

Still, any insistence by the E.C.B. that it should be exempt from the pain of a debt devaluation could be controversial.

The central bank might insist that its holdings be transferred to the European bailout fund, Mr. Pascual wrote.

The E.C.B. began buying bonds from Greece and other countries on open markets last year, via the network of national central banks known as the Eurosystem. The E.C.B. does not disclose the size of its Greek holdings or the prices it paid, but Greek debt was already trading at a substantial discount to its face value when the E.C.B. began intervening in bond markets in May 2010. That means the E.C.B.’s actual losses would be limited.

Meanwhile, bankers are deeply unhappy about plans to make them raise their reserves so that they could absorb the shock if Greece defaults. Some have complained that they are being asked to meet regulatory standards that were not supposed to take effect for many more years.

“What banks would have had by 2019 they want to see in six months, at a time when capital markets are closed,” said Herbert Stepic, chief executive of Raiffeisen Bank International in Vienna.

That could pressure banks to reduce lending not only in Western Europe but in Eastern Europe where Raiffeisen is particularly active, increasing stress on economies there, he said by telephone.

Stefan Krause, the chief financial officer of Deutsche Bank, said Tuesday that the bank could raise capital if needed without resorting to government help. But Deutsche and other banks might need to reduce the amount of money they have at risk, and withhold dividend payments to shareholders. Bankers complain that the pressure to raise capital will force them to restrict lending and hurt the European economy.

The euro fell on the news of the cancellation of the finance ministers’ meeting. It was trading at $1.3921 at midafternoon in New York, down from the day’s high of $1.3960 and from the late New York rate Monday of $1.3929. Stock markets in Europe and on Wall Street, which were already retreating Tuesday, slipped further.

http://www.nytimes.com/2011/10/26/business/global/european-finance-ministers-call-off-pre-summit-meeting.html?pagewanted=2&_r=1&hp