Amid political turmoil and paralysis in Greece, the European Union and IMF blinked, signaling Thursday they'll provide crucial funding needed to stave off the debt-laden country's default. But investors fear that the region's crisis will fester.
The EU will agree on Sunday to give Greece funds already approved as part of last year's bail-out package, said Olli Rehn, a top official. The International Monetary Fund seems ready to release crucial loans, even as the Greek government teeters near collapse over passing a second round of spending cuts and tax hikes.
"As long as the EU and IMF are willing to pay new loans for Greece, debt restructuring is not required. It only kicks the can further down the road," said Carsten Brzeski, economist at Belgium-based ING.
By funding Greece through the summer, the EU and IMF aim to buy time as Europe works on a second bailout for Greece, which clearly won't be able to tap credit markets in 2012 as once hoped. Yields on two-year Greek bonds have spiraled above 30%.
But officials can't agree over private investors' role. Germany wants them to extend the maturity of Greek debt. But the European Central Bank says that could imperil the region's banks. The ECB wants to encourage bondholders to voluntarily reinvest maturing debt into new securities.
An ECB official on Thursday said that the size of Europe's bail-out fund for Greece, Ireland and Portugal should be doubled to $2.15 trillion to calm markets.
Europe isn't coming to grips with Greece's problems, says Guy LeBas, fixed-income strategist at Janney Montgomery Scott.
"Additional aid from the IMF and EU may delay default but haven't solved anything," LeBas said. "Greece needs to owe less. The only way Greece can owe less is through loan forgiveness from the EU and IMF or haircuts (losses) for bondholders."
Some observers say the EU can't restructure Greek debt without doing the same for Ireland and Portugal. Ireland's finance minister roiled markets Thursday, saying senior bondholders should share in the losses of Irish banks.
Violent protests show many Greeks prefer a default to austerity. That could trigger a domino effect, orderly or otherwise. Portugal could strategically default while Ireland could walk away from the debts of its banking system. Fears about Spain are quietly mounting: Its 10-year yield hit an 11-year high on Thursday.
European banks had nearly $190 billion at risk from the debt of Greece, Ireland, Portugal and Spain at the end of 2010, said the Bank for International Settlements in a May report. Interbank yields are moving higher.
The ECB has argued that Germany's Greek restructuring plan would undermine the collateral Greek banks use to get ECB loans . The ECB holds some $65 billion of Greece's sovereign bonds.
The ECB's restructuring stance must change, says economist Ed Yardeni.
"The ECB itself is already a toxic dump; it's greatly impaired as a result of lending to Greek and peripheral banks," he said. "They've got to work with others to develop some creative default schemes that provide banks with lots of slack to raise capital over time."
