Euro zone leaders struck a deal with private banks and insurers on Thursday for them to accept a 50 percent loss on their Greek government bonds under a plan to lower Greece's debt burden and try to contain the two-year-old euro zone crisis.
The agreement was reached after more than eight hours of hard-nosed negotiations involving bankers, heads of state, central bankers and the International Monetary Fund and aims to draw a line under spiraling debt problems that have threatened to unravel the European single currency project.
Under the deal, the private sector agreed to voluntarily accept a nominal 50 percent cut in its bond investments to reduce Greece's debt burden by 100 billion euros, cutting its debts to 120 percent of GDP by 2020, from 160 percent now.
At the same time, the euro zone will offer "credit enhancements" or sweetners to the private sector totalling 30 billion euros. The aim is to complete negotiations on the package by the end of the year, so that Greece has a full, second financial aid programme in place before 2012.
The value of that package, EU sources said, would be 130 billion euros -- up from 109 billion euros when a deal was last struck in July, an agreement that subsequently unravelled.
"The summit allowed us to adopt the components of a global response, of an ambitious response, of a credible response to the crisis that is sweeping across the euro zone," French President Nicolas Sarkozy told reporters afterwards.
As well as the deal on deeper private sector participation in Greece -- which emerged after Sarkozy and German Chancellor Angela Merkel personally engaged in the negotiations with bankers -- euro zone leaders also agreed to scale up the European Financial Stability Facility, their 440 billion euro ($600 billion) bailout fund set up last year.
The fund has already been used to provide help to Ireland, Portugal and Greece, leaving around 290 billion euros available. Around 250 billion of that will be leveraged 4-5 times, producing a headline figure of around 1.0 trillion euros, which will be deployed in a variety of ways.
Leaders hope that will be enough to stave off any worsening of the debt problems in Italy and Spain, the region's third and fourth largest economies respectively.
The EFSF will be leveraged in two ways, either by offering insurance, or first-loss guarantees, to purchasers of euro zone debt in the primary market, or via a special purpose investment vehicle that will be set up in the coming weeks and which is aimed at attracting investment from China and Brazil.
The methods could be combined, giving the EFSF greater flexibility, the euro zone leaders said.
"The leverage could be up to one trillion (euros) under certain assumptions about market conditions and investors' responsiveness in view of economic policies," said Herman Van Rompuy, the president of the European Council.
"There is nothing secret in all this, it is not easy to explain but we are going to more with our available money, it is not that spectacular. Banks have been doing this for centuries, it has been their core business, with certain limits."
PROOF OF THE PUDDING WITH MARKETS
As with the July 21 agreement, which quickly broke down when it became difficult to secure sufficient private sector involvement and market conditions rapidly worsened, the concern is that Thursday's deal will only work if the fine print can be promptly agreed with the private sector, represented by the Institute of International Finance.
Charles Dallara, the managing director of the IIF, said those he represented were committed to making the deal work.
"On behalf of the private investor community, the IIF agrees to work with Greece, euro area authorities and the IMF to develop a concrete voluntary agreement on the firm basis of a nominal discount of 50 percent on notional Greek debt held by private investors with the support of a 30 billion euro official ... package," he said in a statement.
"The specific terms and conditions of the voluntary PSI (private sector involvement) will be agreed by all relevant parties in the coming period and implemented with immediacy and force. The structure of the new Greek claims will need to be based on terms and conditions that ensure (net present value)loss for investors fully consistent with a voluntary agreement."
Euro zone leaders will be hoping the agreement, which will also be accompanied by a recapitalisation of the European banking sector by around 106 billion euros, will finally draw a line under a crisis that has roiled financial markets and threatened to tear apart the euro single currency project.
As with previous deals that have come unstuck, the test will be how financial markets respond once they have digested the details and picked apart the seams of the agreement.
"This is broadly what the market was expecting and I do not see any downside surprise here. Still we have to wait and see more details," said Dan Dorrow, director of research at Faros Trading in Stamford, Connecticut, speaking before the final deal was reached but after some details had emerged.
"They have good intentions and are going in the right direction. This represent a few steps away from the cliff. However, we have to wait for more concrete details but this obviously does not disappoint."
Jose Manuel Barroso, the president of the European Commission, said the final details on the Greek package, which follows a programme of 110 billion euros of loans granted to the country last year, would only be worked out by year-end.
And EU finance ministers are not expected to agree on the nitty-gritty elements of how the scaled up EFSF will work until some time in November, with the exact date not fixed.
As part of efforts to attract investors into the special purpose vehicle attached to the EFSF, Sarkozy said he would talk to Chinese President Hu Jintao in the coming days. Beijing has so far been a big buyer of bonds issued by the EFSF, which is triple-A rated by credit agencies.
Earlier, U.S. stocks rallied after news emerged of the intention to boost the power of the EFSF fund, while the euro fell as investors awaited details that are unlikely to be forthcoming until next month.
As well as the three-way package to strengthen their crisis fighting powers and try to resolve the situation in Greece, euro zone leaders called on Italy to take more rapid action on pension reforms and other structural measures to try to avoid the economy heading the same way as Greece.
Prime Minister Silvio Berlusconi has promised to raise the retirement age to 67 by 2026, and pursue other adjustments to the country's economic model, steps the EU praised but said would only be positive if they were implemented.
"The key is implementation. This is the key. It is not enough to make commitments, it is necessaary now to check if they are really implementing," said Barroso.
Leaving the summit venue at 4.30 a.m., Jean-Claude Trichet, the outgoing head of the European Central Bank, said he was cautiously optimistic that the deal could help stabilise the unrest in European financial markets and economies.
"What I heard in this European Council was the expression of the will of the heads. That is in my opinion extremely important," he told reporters. "What is backing this orientation is the will, the collegial will, if I may, of the heads of state and government that are behind it. But again no complacency -- very hard work, very hard work."