Germany, France Threatened to Let Greece Fail
Business + Economy

Germany, France Threatened to Let Greece Fail

BERLIN — European leaders who agreed to a plan early Thursday to stem the debt crisis gripping the continent spent the rest of the day clarifying the details.

The rescue plan would impose steep losses on investors holding troubled Greek bonds and boost the firepower of the region’s bailout fund.

Investors treated the grand plans with enthusiasm, sending markets higher worldwide. But the announcement did not give major details, and analysts said that the plan’s chances for success still aren’t clear. In particular, the mechanics of how to strengthen the clout of the bailout fund to above a trillion dollars was not spelled out in the statement released by bleary-eyed European officials early Thursday morning.

After marathon negotiations that continued well past midnight Thursday, European leaders said banks and other major investors in Greek bonds agreed to take losses of up to 50 percent. This concession was meant to help prevent the Greek government from defaulting on bills it cannot pay and avoid an even costlier shock to the European financial system.

The losses are much larger than private investors accepted under a deal this summer. Since then, Greece’s economy has steadily eroded, making it even harder for the government to repay its bonds. But until the last minute Thursday, banks had resisted agreeing to take the larger losses.

Luxembourg Prime Minister Jean-Claude Juncker told reporters in Brussels on Thursday that negotiations had all the elements of a gunslinging Old West drama, with German Chancellor Angela Merkel, French President Nicolas Sarkozy and Juncker summoning a top banking official into a room shortly after midnight and telling him that they were ready to let Greece fail if he didn’t acquiesce to their demands that banks take higher losses.

The banking official, Charles Dallara, managing director of the Institute of International Finance, had shortly before the meeting issued a statement saying no agreement had been reached. A few hours later, he was singing a different tune.

Juncker said that a little bit of brinksmanship had done the trick.

“We wouldn’t resist one second to move toward a scenario of the total insolvency of Greece,” Juncker said that he, Merkel and Sarkozy told Dallara, according to Bloomberg. That “would have ruined the banks.”

A German official speaking on condition of anonymity said that it had been the “final offer” from Europe’s top leaders. “It was a difficult summit,” the official said.

The question of how to structure a new refinancing plan for Greece and divide the costs of rescuing it has been at the center of negotiations. Other elements of the plan were dependent on European officials reaching an agreement with negotiators for major banks, which had been balking at taking bigger losses.

Under the deal, the bailout fund, known as the new European Financial Stability Facility, would help cash-strapped countries such as Italy and Spain borrow at least $1 trillion by providing a kind of insurance that would make their bonds more attractive to investors.

The breakthrough at a summit meeting in Brussels came hours after leaders announced they had agreed on measures to shore up the region’s banking system. The 27-member European Union said banks would be asked to raise perhaps $150 billion in new capital as a buffer against possible losses on their holdings of European government bonds that have declined in value.

Once the bank capital plan was announced late Wednesday, the smaller group of 17 European nations that share the euro continued talks over the remaining issues that threatened to scotch an overall deal. Those included how to put Greece’s troubled government finances back on a stable footing and how to best use the limited resources of the bailout fund set up by the euro-zone countries.

Failure to reach an agreement on a new Greek bailout would have seriously set back hopes that Europe’s leaders were finally poised to produce an ambitious plan for addressing the continent’s crisis. U.S. officials, among others, had been pressing them to take strong steps before the crisis spread further.

Speaking early Thursday, European Commission President Jose Manuel Barroso said the set of interrelated measures proves that “Europe will do what it takes to safeguard financial stability.”

The package, he said, makes good on promises top European leaders made to officials from the United States and elsewhere to address Europe’s financial problems more forcefully before a meeting of the Group of 20 top economic powers early next month in France.

Efforts to increase the clout of the bailout fund got a boost earlier Wednesday when German Chancellor Angela Merkel won a strong endorsement from that country’s lawmakers for her plan to re­inforce the fund.

Italian Prime Minister Silvio Berlusconi, meanwhile, came to Brussels with plans to change the country’s pension system and take other steps to balance the budget. Other European leaders had pressed him to accelerate those steps to help build confidence that his nation can manage its large levels of public debt. His proposed changes were endorsed by European leaders, who said they now expect Italy to carry them out.

Because the plan to shore up the banks applies to European economies inside and outside the euro area, the initiative was the subject of deliberations by the full European Union.

Along with increasing bank capital, the plan calls for a new effort by governments to ensure that banks have the funds they need to operate. European banks rely heavily on short-term loans to conduct their business, and the vulnerability of that funding played a role in the recent collapse of the French-Belgian Dexia bank.

Concerns about the European economy have caused many investors, including U.S.-based money-market funds, to pull out of European banks. That development has raised bank operating costs and generated fear that Dexia will be just the first in a series of casualties.

The new plan asks the European Central Bank, the European Investment Bank and other agencies to “urgently explore” a guarantee system so that banks could wean themselves from short-term loans, which often must be renewed weekly or even daily.

Under the plan, banks would have to set aside capital equal to 9 percent of their assets. That represents a significant increase from the 5 percent level used as a standard by the European Banking Authority when it recently analyzed whether the region’s financial firms could weather a new economic downturn.

One concern about increasing relative capital levels is that banks could reach the 9 percent threshold by decreasing their total assets — in other words, reducing how much money they lend to businesses, consumers and governments. Such a pullback could stymie economic growth at a time when it is already slowing in much of Europe.

To head off this prospect, the bank capital plan calls for heightened oversight by regulators to ensure that banks do not achieve the new targets by selling off assets or restricting new loans. Regulators “must ensure that banks’ plans to strengthen capital do not lead to excessive deleveraging, including maintaining the credit flow to the real economy,” the E.U. statement read.

Banks will have until June 30 to meet the new requirement. Some analysts criticized that time frame, saying a quick and broad infusion of money was needed across the European financial system. Banks that cannot raise the money on their own may seek government loans or support.

In winning the endorsement of German lawmakers for her bailout proposal earlier Wednesday, Merkel warned that Europe could be headed for financial disaster if its common currency fails.

“The world is watching Germany and Europe to see if we are ready and able to take responsibility,” Merkel told a packed Parliament before the vote. “If the euro fails, Europe fails.”

Speaking ahead of the emergency E.U. summit in Brussels, Merkel said it should not be taken for granted that “there will be peace and affluence in Europe in the next half-century.” Saying that Europe is facing its toughest period since the end of World War II, she called on the Bundestag, the lower house of the German Parliament, to meet its “historic duty” and back her plan.

After she spoke, lawmakers voted 503 to 89, with four abstentions, in favor of her outline for increasing the power of the European bailout fund.

In her speech to Parliament, Merkel said deep changes must be made to Europe’s economy if the euro is to hold together as a currency. But she offered few concrete details about the steps she would take to protect it. “It’s not possible to have a simple solution,” Merkel said. “We will have to deal with this situation for years. . . . We have a historical obligation to fulfill.”

Schneider reported from Athens.