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Greek crisis averted, but EU's long-term problems remain

French President Nicolas Sarkozy arrives for the EU summit on July 21, 2011 at the European Council headquarters in Brussels.


European leaders rescued Greece from the edge of financial ruin with a massive €159-billion ($216-billion) bailout. But the pain from the continent's long-running sovereign debt crisis is far from over.

Investors around the world welcomed the news of the latest bailout, plunging back into unloved European equities and bonds. Led by a rally in beaten-up bank stocks, Greek equities climbed 2.5 per cent and Italy's main index jumped 3.8 per cent. Yield spreads on bonds issued by Italy, Spain and other heavily indebted euro-zone countries narrowed to their lowest level in two weeks against benchmark German bonds.

But the spreads remain uncomfortably wide. That signals worries persist that the sovereign debt crisis may yet infect other troubled countries and that key longer-term problems - huge imbalances between wealthy and poorer countries and a lack of competitiveness within the euro zone - have not been addressed. Also, the ultimate costs to the governments, banks and taxpayers who will foot the bill are certain to be much greater as the economic and fiscal consequences of the bailout burden and associated austerity measures come home to roost.

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Yields on 10-year Spanish government bonds declined 25 basis points Thursday, but remain at a lofty 5.73 per cent. Just three days ago, they stood at more than 6.3 per cent, the highest level in 14 years. The Italian 10-year yield fell 26 basis points to 5.34 per cent, also sharply elevated from normal levels. Greek 10-year bonds improved to 16.49 per cent.

Rates above 6 per cent make public borrowing almost unsustainable for countries with depleted coffers. Greece, Ireland and Portugal all needed bailouts after bond rates climbed above 7 per cent.

"While this new package of measures goes some way to ring-fencing Greece, Europe's problems are far from completely solved," commented Benjamin Reitzes, senior economist with BMO Nesbitt Burns.

European leaders are still focused on the symptoms of the crisis, and haven't addressed the underlying causes.

"The core issue of concern is the complete failure to deal with actual debt levels" in the heavily indebted countries, said Constantin Gurdgiev, a finance lecturer at Trinity College in Dublin.

Under the terms of the deal, the average loan maturity on Greece's bailout will increase to 15 to 30 years, from 7.5, and the interest rate will be lowered to 3.5 per cent. Ireland and Portugal will get similar breaks on their bailout loans.

But the bailout plan will mean losses for banks, including the European Central Bank, some analysts say.

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"They should have tried to quantify losses to banks, including the ECB, which has €130-billion to €140-billion exposure to Greece through dodgy Greek collateral," said Satyajit Das, a global risk expert based in Sydney Australia. "The ECB and [commercial]banks will need injections of capital."

The plan also hands more authority to the European Financial Stability Facility (EFSF), a €440-billion bailout fund set up to deal with the crisis, to assist countries before they actually need a bailout - a clear attempt to assuage market concerns about the solvency of Spain and Italy, two deeply troubled countries whose debts dwarf those of the smaller euro members. Both are considered far too big to bail out without blowing up the euro zone itself.

The fund, described by French President Nicolas Sarkozy as an International Monetary Fund for Europe, will also have the power to buy up sovereign debt in the secondary market. Such a capability is designed to strike fear in the hearts of speculators, who would face huge losses on bets against Spain or Italy, if the EFSF were to step in.

"The stakes are now considerably raised for investors looking to bet against Italy and Spain, especially when they know that the EFSF can swoop in at any moment," said Marko Papic, a senior analyst with Stratfor, a global intelligence company in Austin, Tex.

But the key new power for the EFSF is the ability to extend credit lines to governments without bailout approval, which is essentially how the IMF operates.

Still, bond watchers say it is too early to tell whether the strategy will ease market pressure on other fiscally challenged countries in the region. "We don't know; we really don't," said David Ader, head of government bond strategy with CRT Capital Group in Stamford, Conn. "Clearly, the effort is a grand plan that might backstop weakness. But the upside [for bond investors]remains in question."

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And major issues remain that could yet come to haunt European officials.

"The only mechanism for reducing the overall debts carried by Greece, Portugal, Ireland, Spain and Italy proposed by the EU leaders is the vaguely defined mandate for the EFSF to purchase their sovereign bonds in the secondary market," said Trinity College's Mr. Gurdgiev.

This mandate requires approval from the ECB and member states, "which implies significant uncertainty as to its effectiveness," he said. Also, such bond purchases "will not have any material impact on PIIGS debt levels, as any discounts in the secondary markets are likely to deteriorate once the program is announced."

The politicians, whose typical idea of long-term planning is how to survive the next election, are well aware that the hard tasks of rebuilding a broken system are only just beginning. Whether they have the stomach for tough measures that will almost certainly prove unpopular in wealthy and poor member countries alike, remains to be seen.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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