Europe's biggest financial powers have worked themselves into a standoff over how to haul Greece out of its debt ditch, with the European Central Bank publicly opposing Germany's demand to make Greece's private creditors share the burden.
The standoff — which pits the region's top monetary authority against its economic powerhouse and bankroller — has unnerved markets as each side seems to have dug into positions that will be difficult to reconcile.
Someone will have to back down by the end of the month, when officials will need to agree on more aid for Greece to keep it afloat.
Germany's parliament on Friday backed demands from Finance Minister Wolfgang Schaeuble that Greece only get more rescue loans if investors agree to get repaid seven years late on their Greek bonds. That would give the country more time to get a handle on its euro340 billion in debt.
"The situation in Greece and therefore in Europe as a whole is serious," Schaeuble told deputies. He warned that without agreement on how to keep aid flowing to Greece there was "an acute danger of Greece being unable to pay its debts, with grave consequences for the euro area."
Germany's demand on bondholders is a key condition to rally support among the German public and lawmakers in Chancellor Angela Merkel's coalition, some of whom are restless at the idea of funding continual rescue loans for Greece. As the eurozone's largest country, Germany puts up the biggest share.
The vote is a gesture of support for Schaeuble as he gets ready for a June 20 meeting of finance ministers on more aid for Greece.
But facing off against Schaeuble at that meeting will be Jean-Claude Trichet, the head of the ECB, who says Greece must not change the terms of its debt in ways that put it in official default.
Ratings agencies have said that a bond repayment that materially disadvantages bondholders would be considered a default. Key details, such as interest rates and any collateral provisions, are lacking from what Germany has proposed, but it is hard to see how bondholders could agree to an extension at the lower rates that were current several years ago, given the clear risk of default. Higher rates that markets are demanding now to compensate for the added risk are what have made it impossible for Greece to borrow.
"No credit event," Trichet repeated at his monthly news conference Thursday when asked about the German demand, using the technical term for a default ruling by credit agencies. Anything that brings that on would be "an enormous mistake," he said.
The euro slid in the wake of his remarks and uncompromising tone.
The banks says that any kind of default could worsen the financial crisis and spread more market turmoil. Greece, Portugal and Ireland have all been bailed out by the European Union and the International Monetary Fund after bond markets refused to lend them more money at less than exorbitant interest rates.
Schaeuble said that he took the ECB's warnings "very seriously." He said a group of officials from the IMF, ECB and the European Union's executive Commission would work to find the "fine line between quantifiable participation by the private sector and avoiding negative consequences on financial markets."
He said a solution would have to be supported by the ECB.
Yet ratings agencies have made clear that it will be difficult to craft a change in the terms of Greece's debt that does not lead to a ruling of default. Key elements are whether any change costs bond holders money, not just in lost principal but in foregoing higher rates of interest as well.
A default rating on Greece would put the ECB, and Greek banks, in a very tough spot, since the ECB says it will in that case no longer take Greek government bonds as collateral for emergency loans to banks. That could bring down Greece's banks — a catastrophic outcome that has economists openly dismissing the possibility that the bank would carry through on its threat.
Some analysts think that, by not ruling out a voluntary debt exchange or rollover, the ECB is subtly leaving itself room in case it has to retreat.
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