Back to square one on eurozone debt crisis

FRANKFURT – After a glimmer of hope in the Greek debt crisis, is it back to the drawing board for eurozone leaders as they struggle to protect the single currency and its 17-nation economy?

“That’s for sure … that’s why the ECB has probably always had the position that having talks about private sector involvement was not a particularly brilliant idea,” UniCredit chief eurozone economist Maro Valli told AFP.

Bogged down in how to square the circle of pulling Greece out of a quagmire again without triggering a potentially fatal debt default, European Union leaders thought they had found a way out by involving the private sector.

If PSI, as it is known, was obtained on a ‘voluntary’ basis and took some of the burden of a second Greek bailout, it would reduce the sums governments had to put up and pacify taxpayers peeved at having to pay all over again.

Formalised in a French plan for private banks to rollover Greek government bonds as they came due, things looked good until ratings agency Standard and Poor’s said last week that such an arrangement would be tantamount to default.

To add insult to injury, Moody’s slashed its Portugal rating to junk status, in part because the French plan not only “increases the economic risks facing current investors but also because it may discourage new private sector lending going forward.”

That could “reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms,” making a second bailout for Lisbon a real possibility as well, Moody’s said.

In other words, the Portuguese bailout negotiated only months ago would likely not work – and by implication, last year’s Irish rescue could fail too.

Germany then leapt into the fray by reviving a Greek bond-swap proposal the European Central Bank (ECB) has already rejected.

The resulting impasse leaves the idea of PSI almost dead in the water while markets demand ever higher rates of return to provide funding for weak eurozone members, and Italy and Spain are now at risk of being sucked in.

ECB president Jean-Claude Trichet “warned about that several times but politicians do not seem to hear it,” Valli noted.

“I would not be surprised, if current market tension persists, that private sector involvement could be shelved for good,” at least regarding the second Greek rescue, he added.

Economists say that even if PSI were to work, institutional investors will not come up with anywhere near the 20-30 billion euros certain politicians have suggested out of a total package worth some 100 billion euros ($143 billion).

The ECB has contributed to the tension by stressing that if private sector involvement led ratings agencies to declare Greece in default, it could no longer accept Greek government debt as collateral for loans to Greek banks.

That would probably cause the Greek banking sector to collapse.

“If the ECB stuck to its guns, it would be the ECB proper that would actually transform something that is already pretty bad into something truly catastrophic,” Deutsche Bank senior economist Gilles Moec told AFP.

Economists doubt the ECB will take that risk, rather they believe it wants eurozone governments to take responsibility for resolving the debt crisis, as Trichet stressed again on Thursday.

The idea of a Greek default, in full or even partial and short-term, was totally unacceptable at this point, he said.

“No credit event, no selective default, no default. That is the present message of the (ECB) governing council,” Trichet said.

Some critics noted that by hiking its benchmark lending rate to 1.50 percent Thursday to tackle rising inflation, the ECB added to the pressure on debt-laden eurozone members.

The central bank, however, still lends unlimited amounts of cash to commercial banks in those countries and has bought huge amounts of their public debt on secondary markets, a way of providing exceptional financial support.

In the end, more and more economists expect Greece to default on its debt, vociferous eurozone and ECB denials notwithstanding, which some say would provide a chance to create a full-blown, centralised fiscal union.

“At some stage an outright, big bang-like step into a fiscal union might be the only way to keep the euro area alive,” UBS economist Stephane Deo said