Europe divided over whether to ease up on Greece

Associated Press
Customers browse discounted goods for sale at a "one euro store" in Athens, on Monday, June 18, 2012. Europe looked on with wary relief Monday as Greek conservative leader Antonis Samaras received a mandate to launch coalition talks after coming first in national elections that follow weeks of uncertainty over the debt-crippled country's future in the continent's joint currency. (AP Photo/Petros Giannakouris)
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BRUSSELS (AP) — European leaders are locked in a fierce debate over how to solve the debt crisis that is killing off growth on the continent, including whether to ease up on the terms of Greece's bailout deal.

A European Union official says worsening economic conditions have made Greece's current bailout agreement an "illusion," but Germany is resisting any changes.

A narrow victory for the New Democracy party in elections over the weekend in Greece means that the country is more likely to stick to the harsh austerity terms of its €240 billion ($300 billion) bailout packages and avoid a chaotic exit from the euro in the very near future — an event many fear would destabilize Europe and send shockwaves around the world.

However, news of the election result has not given Europe the breathing space it needed to sort out its problems.

Greece's economy is still in a very vulnerable state. The country is in a fifth straight year of recession and could easily deteriorate to point where a default and euro exit are inevitable. It is looking to renegotiate some of the harsh austerity terms and conditions of the rescue loans it relies on to pay its bills — something that other European countries such as Germany are opposed to.

However, the EU official speaking in Brussels on Tuesday argued that the terms of Greece's bailout had to be renegotiated because poor economy has left Greece behind in meeting its targets.

The official, who spoke on condition of anonymity, citing policy, said that the goals of the agreement would not be changed: They remain to reduce Greece's debt to a level that is sustainable and reform its economy to make it competitive. But how those goals are achieved — and over what time period — is up for discussion.

These disagreements are in contrast to the united front leaders of the world's largest economies gathered for the G-20 summit in Mexico tried to present.

The presidents and prime ministers sought Tuesday to reassure the world that they would find a way to put out the debt-fueled economic wildfire. Still, the leaders seemed content to delay any major decisions for a while longer, releasing only a general statement that stopped short of committing any nations to greater spending unless conditions worsen and urging fiscal responsibility.

President Barack Obama said European leaders 'grasp the seriousness' of their debt crisis and are moving with 'heightened sense of urgency' to find a solution.

In a news conference following the summit in Los Cabos, Mexico, Obama said the economic problems in Europe won't be solved by the G-20 or the United States, but by European nations.

He said he was confident they could do that, but acknowledged the difficulty of getting all the separate legislatures to agree.

Meanwhile, heavily indebted Spain and Italy continue to see their borrowing costs rise, increasing pressure on their government finances and keeping alive fears that another big bailout might be needed. That would considerably strain the eurozone's ability to protect its members and keep the currency union together.

Finance ministers from the 17 countries that use the euro meet in Luxembourg on Thursday to discuss how best to solve the problem, which threatens to place ever greater burdens on national budgets and further destabilize the region's economies. Europe is a substantial trading partner with the rest of the world. If it falls into a deep recession sparked by a Greek exit of the euro or a massive bailout for Spain or Italy, orders for U.S. and Chinese goods are going to start falling off.

Here's a look at the latest developments in Europe:

—GREECE

The debate over whether Greece's bailout terms should be renegotiated is at the heart of Europe's crisis response. With economic conditions in Greece worsening by the day, the EU official said that said that renegotiating bailout terms — known as the "Memorandum of Understanding" — was only natural. He added that it was part of the normal process of assessing the progress of any country that has received an international rescue.

And he noted that Greece's progress has clearly slowed as the recession drags on, unemployment has soared to 22 percent, and many Greeks are struggling under the cost cuts and tax hikes imposed in exchange for the rescue.

"Anybody who would say we cannot renegotiate the MoU is delusional," he said. "If you were not to change the MoU, we would be signing off on an illusion."

But it's unclear if any renegotiation would go that smoothly. Germany — whose economy is the largest of the 17 countries that use the euro — has held a firm line in recent days, saying it wants Greece to continue to use the euro, but that it must hold up its end of the bargain.

Chancellor Angela Merkel said on the sidelines of the G-20 summit in Mexico on Monday that "we have to count on Greece sticking to its commitments" and that "no departures can be made from these reform measures."

She didn't address whether Greece could be given more time, and officials in Berlin avoided committing themselves to that.

Germany's position reflects voter concerns at home: Its government is footing a large part of the bill for Greece's rescue, and it needs to be able to show its citizens that Greece is taking the right steps to ensure it can pay down its debt and never ask for another bailout.

— SPAIN

Spain paid sharply higher interest rates in a short-term bill auction on Tuesday, highlighting growing investor concerns that the country might eventually need a bailout itself. The Treasury raised €3.39 billion ($4.28 billion) in 12- and 18-month bills — more than its upper target of €3 billion —but its borrowing costs skyrocketed.

The auction — together with the fact that Spain's borrowing costs on its 10-year bonds remain above at 7 percent — show that markets are deeply skeptical about whether the country will be able to manage without a bailout like the ones received by Greece, Ireland and Portugal's. It also highlights doubts about Europe's ability to contain and end the crisis.

Marc Ostwald of Monument Securities said that while Spain met its sale target for the debt auction on Tuesday, "the yields at which these were sold can only be described as prohibitively expensive."

Spain is bigger than the three bailout countries combined, and would stretch the eurozone's €500 billion bailout fund if help were needed. Worries about Spain's ability to repay its debt grew last week when the country agreed to accept a eurozone loan of up to €100 billion to shore up its ailing banks, which are sitting on massive amounts of soured real estate investments.

Spain not only needs a eurozone rescue package for its banks but "an outright bail-out package," Ostwald added. "It is becoming very difficult to see how it can manage without that beyond the end of the third quarter, unless yields fall dramatically!"

Italy has also been caught up in concerns that it might soon be able to keep a lid on its debt without help. Its economy is the third largest in Europe, after Germany and France, but it has a massive amount of debt. The worry is that if Italy's economy continues to slow, it won't be able to maintain its debt. Italian borrowing costs Tuesday were at 5.79 percent — while Germany's stood at 1.53 percent and France's were 2.56 percent.

— FINANCE MINISTERS' MEETING

In addition to wrangling over Greece's bailout terms, the eurozone finance ministers meeting in Luxembourg on Thursday are expected to discuss how best to help Spain and Italy deal with soaring borrowing costs.

At the moment, the debate centers on whether to take the drastic step and push for a stronger banking, fiscal and political union across Europe in order to rescue the single currency. But there are concerns, especially in Germany, that this is a long-term solution and can't be rushed into.

Analysts also warn that while fiscal union may solve the larger question of governments spending beyond their means, it will not address the immediate concerns of countries struggling to pay tomorrow's bills.

As a bridge to a longer-term solution, Gary Jenkins of Swordfish Research, a bond research consultancy, suggested that the only way out of the current mess is to form what he calls a "quasi-fiscal union."

He suggested that each of the 17 countries that use the euro could cease for a certain period, say five years, to go to the markets individually to borrow money. Instead, the eurozone as a whole would issue bonds and then distribute the money raised to countries to fund their budgets.

There are some very large and powerful opponents to the idea of these "eurobonds" with Germany being the biggest.

Jenkins is sympathetic to Germany's concerns that once countries no longer have a market check on how expensive it is for them to borrow, they'll blow their budget commitments.

But, he argues, it would give Europe a chance to rebuild its finances without having to fight a lot of different fires. "Under a minimum, it gives you some breathing space, it gives you a time of no pain," he said. "No one talks about Italy, no one talks about Spain."

Michael Hewson, a senior analyst at CMC Markets, an online trading platform that also provides market research, also thinks that fiscal union is the only way to save the euro. But, he added, giving up sovereignty over national budgets would probably be untenable without broad consent from voters, and that takes time.

In order to buy that time, Hewson thinks both Spain and Italy will need at least short-term bailouts. But he's not even sure that there's enough money to do that, given how substantial Italy's funding needs are.

"They didn't build the foundations before they built the first floor," he said. "There are now no easy solutions."

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Associated Press writers Nicholas Paphitis in Athens, Geir Moulson in Berlin, Daniel Woolls in Madrid and E. Eduardo Castillo and Michael Weissenstein in Los Cabos, Mexico, contributed to this report.

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