US raises pressure on EU to end crisis

Washington has increased the pressure on the EU to resolve the debt crisis, especially the Greek case, by pushing for the eurozone to take a hit on Greek bonds.

Negotiations in Athens over a potential 50% writedown on private sector bonds have been bumpy over the past few days. Greek government spokesperson Pantelis Kapsis said that the talks were at their most delicate phase but they planned to wrap up the deal by the end of the week.

Christine Lagarde, the IMF’s managing director, yesterday repeated her threat, first made on Monday, that public sector holders of Greek debt may need to take a haircut if the private sector restructuring is not enough.

EU finance ministers on Monday rejected a deal put forward by the International Institute of Finance for a 4% average coupon on new, longer-dated bonds in exchange for existing debt. The private sector holds 60% or about €200bn and a writedown of at least 50% has been demanded.

The US is becoming increasingly nervous about the effect the ongoing crisis in the eurozone is having on the world economic outlook, especially after the latest IMF report that forecasts a sharp deterioration globally.

Lagarde has been pushing for the eurozone to increase its financial backstop and ensure the current and new bailout funds are combined to create a pot of at least €750 billion, which could then be leveraged further.

So far, however, despite agreeing that the new fund, the European Stabilisation Mechanism, will be a year early introduced in July, Germany has refused to increase its €500bn fund or to allow the €250bn remaining in the EFSF to be added to it.

The haircuts on the Greek debt were to bring down the debt to €120bn by 2020, which was seen as being sustainable. But because of the deteriorating economic situation in the country and globally, and fears that the writedown will not be sufficient, the debt is likely to remain higher than is considered sustainable.

European finance ministers have said that Greece will have to make additional adjustments to make up the difference, but the reality is that all of this increases the likelihood of a hard default by Greece with dangerous ramifications for the rest of the eurozone.

As a result, Ms Lagarde, under intense pressure from several members of the IMF, especially the US, has suggested the slack should be made up by the European Central Bank and the eurozone’s central banks; or that the eurozone increases the size of the backstop.

Both avenues will cost eurozone countries, and especially Germany, that have been criticised for failing to put up their own considerable resources, preferring instead to ask other countries through the IMF to provide funding.

The ECB has a portfolio of sovereign bonds including Italian, Spanish, Irish and Greek. Since they are not allowed to hold sovereign bonds of a member state, as it would be seen as subsidising the state’s finances, they are bought for intervention purposes, to protect monetary policy.

These are bought at face value and each year, as they come closer to maturity when they expect to be paid their full value, they are revalued. The latest amortisation at the end of 2010 showed that none of the sovereign bonds were impaired.

If there was a writedown on Greek bonds for the ECB, the losses would be distributed according to the ECB key among national central banks, to which profits are normally returned.