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Busch: Options for EU Debt Negotiation

Euro Zone finance ministers met yesterday and released a statement overnight that created these headlines:

  • We Reaffirm Commitment to Safeguard Stability in Euro Area
  • We Stand Ready to Adopt Further Measures to Improve Euro Area Systemic Capacity to Resist Contagion
  • This Includes Enhancing Flexibility and Scope of EFSF Rescue Fund
  • Steps Also Include Lengthening Maturities of Loans and Lowering the Interest Rate on Loans
  • Proposals to This Effect Will Be Presented to Ministers Shortly

Also, there have been a slew of comments coming from the individual finance ministers, which have generated larger moves in the financial markets as pessimism about a cure have increased. The early commentary was mainly negative and added to the “Risk-Off” nature of the markets. Subsequently, we’ve had more constructive discussions and talk of a potential leaders summit on Friday.

Distilling down the commentary and newspaper articles, here’s what the choices appear to be at this time:

  1. A limited Greek default (Guardian newspaper, bit dodgy)
  2. Extend EFSF loan maturities and reduce interest rates
  3. Use EFSF facility to buyback discounted Greek debt and retire debt.

I believe all three are would require EU country approval and may need to be addressed on a constitutional basis. Each solution has advocates and detractors within the Euro Zone and therefore the outcome for each is in question. Again, this is adding to the tremendous uncertainty in the markets and the selling of both sovereign debt and bank stocks.

What is known is that the stop-gap, piecemeal approaches to Greece, Ireland and Portugal are not working. What is known is that the markets are not waiting for a new solution to reduce their exposure and risk to Europe and European banks. What is also known is that once a sovereign crisis spreads to the banking system, the problem becomes acute.

My outlook is that Greece’s bailout will be addressed and a paradigm developed for all of the Euro Zone. Next, I believe that Greece will have to restructure and thereby default on their debt (See BU 6/13 for potential form).

Finally, I believe there will be a bank capital injection program similar to the TARP program in the United States to shore up European financial institutions. Remember, the US financial crisis didn’t stabilize with TARP, but only after Bernanke went on 60 Minutes and stated no major bank would fail on his watch.

The timeline is fluid but will likely be sped up the lower prices go for European bank stocks and European sovereign debt.

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Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.