Euro rescue plan must surmount series of obstacles

ANALYSIS:SEVERAL HURDLES stand in the way of euro zone leaders as they gather tonight in Brussels to hammer out a big new rescue plan for the euro zone.

Not only must they conclude talks with global banks on a plan to restructure Greece’s debt, but they must also settle measures to expand the firepower of Europe’s bailout fund and recapitalise weak banks.

If the tension was not high enough already, a new threat to Italian prime minister Silvio Berlusconi adds to the drama.

A deal to boost the banks by some €108 billion is done, but it is contingent on the other elements of the plan. By far the most contentious is the Greek question, which seems set to go to the wire.

The banks won’t play ball on the push for a “voluntary” 60 per cent default. Those with the biggest exposure to Greece face the greatest loss and the biggest upfront requirement for new capital. That requirement will be all the greater if they have large holdings of bonds of other weak euro countries.

A key feature in new stress tests is that the need for capital is measured for the first time against the market value of sovereign bonds. This means some banks will have no hiding place when it comes to raising fresh capital.

Private investors are unlikely to jump forth with capital in a scenario like that. This increases the likelihood of state aid, nationalisations and, ultimately, the deployment of emergency aid from Europe’s bailout fund to fill any remaining gap.

In that context, it is no wonder that the banks have hardened their stance in talks with Europe. Similarly, the decision of EU leaders to take the previously “unthinkable” option of a large Greek writedown means it is now in their interest to seek to maximise the haircut.

Quite how this plays out today remains to be seen, but it represents a decisive moment in the turmoil set off two years ago by Greece’s admission that its public finances were falsified.

If the drive to cut Greece’s debt is the main event today, German chancellor Angela Merkel must still secure a parliamentary mandate to negotiate a change to the remit of the European Financial Stability Facility.

This seems assured, although questions remain as to the extent of the majority she receives. Dr Merkel left nothing to chance, saying her position must be “to get the best for Germany” and for Europe. “I am bound by my oath of office to avert damage for the German people, to do good for the German people. That must be the guiding principle in my negotiations,” she said.

Changes to the bailout fund could take weeks to execute, raising questions as to when it could support Italy and Spain on bonds. The hope is the ECB will step up, but Dr Merkel said leaders should not be seen to tell it what to do. All considered, it’s the least of her worries.