Why the €1 Trillion Deal to Save Europe Has Fallen Apart
Condensed article from Foreign Policy Magazine.
It all sounded so promising. In the early morning hours on Oct. 27, German Chancellor Angela Merkel and French President Nicolas Sarkozy emerged from a day of edge-of-their-seats negotiations and announced a historic plan to pull the continent’s economy back from the brink of disaster.
The agreement… had three parts:
1. Investors — mostly European banks — would write off half of the face value of the Greek bonds they held, a particularly toxic ingredient in Europe’s debt crisis.
2. The banks would raise capital to the tune of 100 billion euros, removing some of the uncertainty over the shaky sovereign government debt on their books.
3. And the European Financial Stability Facility (EFSF) — the continent’s 625 billion-euro bailout fund — would be bolstered to 1 trillion euros in order to protect other vulnerable economies from imploding the way Greece’s had.
Unfortunately, it didn’t take long for the expectations from last week’s summit to come crashing down to Earth, and loudly.
The result has been significant market turmoil as three developments essentially unraveled the summit’s achievements.
First, in a surprise move, Greek Prime Minister George Papandreou announced he would hold a national referendum to seek broad-based popular support for the measures agreed upon last week. This baffled other European leaders, who were under the impression that Papandreou and his government had already signed off decisively on the deal. It also cast major uncertainties over the willingness of the European Union and the International Monetary Fund (let alone countries like China) to lend to Greece ahead of the referendum — which is still pending a vote in Greece’ parliament — thereby increasing the risk that the country could run out of money this month to pay some bills.
Second, some banks that hold Greek debt started expressing reservations about the agreed-upon 50 percent debt reduction — a haircut they had initially hoped to keep to 21 percent.
Third, the European Central Bank (ECB) has proved less than fully effective in stabilizing the interest rates on debt issued by other European economies, particularly that of Italy. Despite purchases by the ECB, the interest rate on Italian 10-year bonds has broken above 6 percent, more than double the level considered safe… While it is not clear whether it is an issue of willingness or ability on the part of the ECB to stabilize markets, the disappointment has added to market jitters.