Dark clouds over the euro area

The decision reached at the emergency summit in Brussels Thurday will be judged by whether it eventually succeeds in making Greece?s debt sustainable without resulting in serious side effects for the eurozone. This means that the country?s mammoth debt has to be reduced to a size that will be serviceable without outside help. The debt reduction is seen coming through a bond haircut, an extension to the repayment period combined with lower interest rates or the purchase of bonds on the secondary market — or even a combination of the above.

Let the governments of the eurozone pick the right mix. However, any reduction has be enough to make the Greek debt sustainable. That would not just be in Athens?s interest; it would also be in the interest of bondholders in the euro area. If the reduction is too small to render the debt serviceable, the markets will continue their attacks and the crisis will continue, increasing the risk of an uncontrolled bankruptcy. Greece would in that case look to a fresh restructuring — at best.

In light of the above, it?s hard to make sense of the debate in Greece about a selective default. The label that credit rating firms choose to describe the development concerns people who trade in credit default swaps — not Greece. The argument that the European Central Bank will reject Greek bonds as collateral fails to take into consideration that the European Council will only announce a decision if it has the OK from Jean-Claude Trichet. That is, after all, why German Chancellor Angela Merkel and French President Nicolas Sarkozy invited the ECB president to their talks in Brussels. In other words, providing liquidity to Greek banks is a vital component of any agreement.

That said, it is unacceptable that public debate is distorted by intimidating terms. Those who rule out any private contribution must provide an explanation as to why it is wrong to demand that banks pay part of the cost. The claim that it would push up interest rates is debatable — but it does not concern Greece, which is cut off from the markets. Issuing Eurobonds would be a solution, but the necessary consensus does not exist.

Greece must seriously decrease its debt; not just for the country but because dark clouds are gathering over the euro area.