After an all-night emergency meeting in Brussels – the second within four days – Europe's leaders have decided on a range of measures that may build confidence globally that the eurozone is getting a grip on sovereign debt and can find a way out of the crisis.
But while the plan gave observers and global financial markets reason for cautious optimism, the measures' success will turn on the specifics.
“This is a big step in the right direction,” says Thomas Huertas, former head of European Banking Authority. “The details, though, will have to be worked out now by finance ministers, regulatory authorities, and the banks.”
Europe's leaders had to find agreement on three main issues to overcome the worst crisis in over 60 years: To increase significantly the firepower of the eurozone’s bailout fund, the EFSF; to involve private creditors in the restructuring of Greek debt to a much higher degree than previously planned; and to persuade European banks to accept an unpopular recapitalization program designed to enable them to withstand future write-offs of sovereign debt within the eurozone.
On the face of it, Europe’s leaders came up with bold numbers. Banks and other private creditors agreed to write off 50 percent of Greece’s debt – worth about 100 billion euros ($140 billion). This should help Greece to decrease its debt rate from 160 percent now to 120 percent in the year 2020. On top of that, the country will receive another 100 billion euros in loans from European institutions within the next three years.
“The whole exercise of the summit was to bring credibility and stability back into the system,” says Ulrike Guerot, senior research fellow at the European Council on Foreign Relations. “They held 14 summits since the beginning of the crisis and not one of them managed to convince the markets. So this time they had to be bold.”
To prevent banks from coming under pressure themselves when writing off a portion of the debt of Greece or other potential candidates, the EU has asked them to increase their rate of capital resources from currently four to nine percent. According to the European Banking Authority they have to raise 106 billion euros, which they are supposed to get at financial markets. If the banks are unable to raise the capital, they can turn to national governments for help, and as a last resort to the eurozone bailout fund, the EFSF.
The fund’s capacity to help banks and governments has been increased, not by putting more money into it, but through so-called leverage, achieved by a combination of two things. One is insurance: Rather than buy government bonds of ailing countries, the fund guarantees parts, maybe 20 percent, of the bonds, thus using the existing amount of the fund’s 440 billions euros ($610 billion) to entice five times as many investors to buy them. The second part of the leveraging mechanism consists of so-called special purpose vehicles, allowing a wider range of investors, including state-owned funds, to buy government bonds. All in all, this should boost the EFSF’s capacity to 1 trillion euros ($1.4 trillion).
The markets seem to indicate support for the plan. The euro strengthened and stocks rose at Asian and European markets in reaction to the summit’s results. “This is good news, but far from crisis over,” says James Ashley, Senior Europe Economist at RBC Capital Markets in London. “Particularly on boosting the EFSF we don’t have full disclosure yet of how that is supposed to work, so we are waiting to see the fine print.”
Greek Prime Minister George Papandreou chose to see the big picture, saying: "We can claim that a new day has come for Greece, and not only for Greece but also for Europe."
All eyes are now on Italy, which has come into the focus of rating agencies lately, sitting on 1.9 trillion euros ($2.7 trillion) of debt. The government of Prime Minister Silvio Berlusconi has been reluctant to introduce reforms. Only under pressure from his eurozone colleagues, Mr. Berlusconi promised measures like raising the retirement age to 67 by 2025 and presenting a balanced budget by 2013.