Old rescue ideas resurface while markets take fright

(Reuters)-Seen from Greece, there is something faintly surreal about watching European authorities and banks trying and failing to work out how to involve private sector bondholders in another rescue of Athens.     The damage this wrangling is causing to the euro zone's credibility appears out of all proportion to the money it might raise towards funding the bloc's most distressed debtor.     Just when Greece hoped for breathing space after adopting a new five-year austerity plan despite fierce street protests, acrimonious talks on making private bondholders pay have wrecked any honeymoon.     Markets have taken fright. The borrowing costs of hitherto "safe" euro zone countries such as Spain and Italy are rising, and depositors are pulling funds out of Greek banks in growing numbers.      To assuage domestic political interest groups, especially in Germany, Europe is fiddling while Athens burns.     German, Dutch, Austrian and Finnish lawmakers, furious at having to bail out peripheral euro zone countries seen as having lived beyond their means, are demanding that banks and insurers share the burden of any further assistance to Greece.     "While this objective is generally welcomed by some countries' taxpayers, who certainly are attracted to the idea that their money should not be used to bail out banks, it can under certain circumstances -- in particular in the midst of a financial crisis -- lead to outcomes which are even more costly for them," European Central Bank policymaker Lorenzo Bini Smaghi told a conference of the Eliamep think-tank.     The ECB has warned against any form of private sector involvement that would trigger either a payout of credit insurance or be adjudged by ratings agencies to constitute a selective default.     Germany has said it expects 30 billion euro in private sector involvement, the Netherlands has called for 50 billion, and Finland's government has demanded collateral for any money it lends.     But by insisting that the private sector be made to pay, politicians may bring about precisely the Greek default they say they want to avoid.     "This is much more complicated than negotiating a debt restructuring," said a senior French private sector source, who was involved in debt rescheduling in a previous job as a government official.     "In a classic debt restructuring, you have the defaulting sovereign on one side of the table and the creditor banks on the other, with the International Monetary Fund as midwife," he said.     These negotiations are bewilderingly complex, involving private banks, state banks, insurers, governments, the European Commission, the European Central Bank, credit ratings agencies, accountants and a derivatives arbitration body.     Banks and insurers own less than half of Greece's 340 billion euro debt. About 50 billion euros is with the European Central Bank.      Pension funds, asset management companies and hedge funds own an estimated 140 billion euros in Greek debt, but they have so far not been involved in any bailout negotiations.     French banks, which have the biggest exposure to Greek sovereign debt, came up with an ingenious plan for a voluntary rollover of half of Greek bonds maturing in 2011-14, with part of the money going into a guarantee fund of zero-coupon AAA-rated bonds that would effectively insure the new Greek bonds.     The new bonds and the guarantee fund would be held by a Special Purpose Vehicle, enabling banks to get Greek debt off their balance sheets.     Put together by BNP Paribas chairman Michel Pebereau, the scheme looked on closer inspection like a bailout for French banks rather than help for Greece, which would have to pay a coupon of up to 8 percent on the new bonds -- nearly double what it pays on average for EU/IMF loans.     At a series of chaotic meetings last week, bankers appeared to move further away from agreement rather than converging. Old ideas such as Germany's proposal to swap all Greek bonds for new ones with an extra seven years' maturity resurfaced.     The European Commission and the ECB revived their call to allow Greece to use long-term bailout loans to buy back some of its own debt at a discount in the secondary market, reducing its debt stock and debt service payments.     Each of these suggestions had been aired and rejected in the past.     Charles Dallara, managing director of the Institute of International Finance (IIF), a bank lobby group, who chaired talks in Paris, said they were looking at a range of options, including possible debt buy-backs -- a solution EU paymaster Germany rejected in February.     Euro zone diplomats said the talks have stalled and there seems little chance of reaching even the 30 billion euro target figure sought by Berlin.     "It's all shadow boxing, it's a phantom debate," said Jens Bastian, a former banker and EU official now at Greece's Eliamep think-tank.     "It's all because (German Chancellor Angela) Merkel and (Finance Minister Wolfgang) Schaeuble are worried they will not have sufficient political legitimacy to get a second bailout package through parliament unless they can show private sector involvement," he said.     Some analysts suspect the talks are really a dry run for a debt restructuring negotiation down the road -- something vehemently denied by European governments.     "This is about who will take the losses when the time comes," the private sector banker said.     The more acrimonious the talks become, the more likely it is that Greece's day of reckoning will come before anyone is ready to handle it.