Greek gloom rocks markets, troubles lenders (Reuters)

By Harry Papachristou and Jan Strupczewski Harry Papachristou And Jan Strupczewski – Mon?Oct?3, 8:29?am?ET

ATHENS (Reuters) – Greece's admission that it will miss its deficit target this year despite harsh new austerity measures sent stock markets reeling on Monday and raised new doubts over a planned second international bailout.

The gloomy news from Athens brought the specter of a debt default closer and will weigh on talks among euro zone finance ministers in Luxembourg later on Monday on the next steps to try to resolve the currency area's sovereign debt crisis.

European bank shares suffered the heaviest falls on fears that private sector bondholders may be forced to absorb bigger losses than agreed in a July rescue plan for Greece, which was based on more optimistic growth forecasts.

The draft budget sent to parliament on Monday showed this year's deficit would be 8.5 percent of gross domestic product, well off the 7.6 percent agreed in Greece's EU/IMF bailout program.

Finance Minister Evangelos Venizelos said in a statement that the 2012 fiscal targets would be met in absolute terms and Greece would have a primary surplus before debt service for the first time in many years.

However, next year's deficit is projected to be 6.8 percent of GDP, rather than the 6.5 percent EU/IMF goal, because the economy is set to shrink by a further 2.5 percent after a record 5.5 percent contraction in 2011.

Deeper-than-forecast recession means public debt will be equivalent to 161.8 percent of GDP this year, rising to 172.7 percent next year, by far the highest ratio in Europe.

Deputy Finance Minister Pantelis Oikonomou said the European Union and International Monetary Fund inspectors had "essentially concluded" negotiations to give Greece a crucial 8 billion euro installment of aid this month to avert bankruptcy.

However, a source familiar with the review by the "troika" of international lenders said the talks were not over, and the inspectors were still examining both the budget numbers and other reforms required for the loan disbursement.

The 17 euro zone ministers will not take any decision on Monday on releasing the funds, needed to pay October salaries and pensions, since the troika has yet to report back. They are set to decide at a special meeting on October 13.

The likelihood that Greece's funding needs next year will be greater than forecast when a second 109 billion euro rescue package was agreed in principle in July reopened a fraught battle over who should pay -- taxpayers or financiers.

STEEPER HAIRCUT?

Deutsche Bank chairman Josef Ackermann, head of the International Institute of Finance (IIF), which negotiated a "voluntary" bond-swap by investors as part of the bailout plan, warned at the weekend against changing the terms now.

"If we reopen the voluntary accord of July 21, we will not only lose precious time but quite possibly also private investor support," Ackermann told the Sunday edition of Greek newspaper Kathimerini.

"The impact of such a move will be incalculable. This is why I am warning in the most forceful way against any material revision," he said.

Private bondholders agreed to a 21 percent write-down on their Greek debt holdings but EU and German officials have suggested the "haircut" may have to be increased in light of a new funding shortfall and changed market conditions.

"Ultimately, Greece would need to see its debt written down by more and with that you need probably some kind of shoring up of the banking sector," said Alec Letchfield, chief investment officer at HSBC Asset Management.

Political resistance to pouring more public money into euro zone bailouts is growing across northern Europe.

"Greece is bankrupt," said Michael Fuchs, a deputy parliamentary floor leader in German Chancellor Angela Merkel's Christian Democrats, reflecting a growing mood in Berlin.

"Probably there is no other way for us other than to accept at least a 50 percent forgiveness of its debts," Fuchs told the Rheinische Post newspaper.

FLIGHT TO SAFETY

Uncertainty over the extent of damage to the already fragile European banking sector from a possible Greek default has been driving investors to take refuge in safer assets.

Yields on Spanish and Italian government bonds rose and the cost of insuring their debt against default spiked on the news from Greece, while money poured into safe-haven German Bunds. The euro fell to an eight-month low in Asia.

"The markets continue to conclude that a default for Greece is an inevitability and a question of when rather than if," said Nick Stamenkovic, strategist at RIA Capital Markets.

The euro zone ministers were expected to discuss ways to leverage their EFSF bailout fund, without reaching a conclusion on Monday, and to put more pressure on Greece to implement agreed structural reforms and privatizations to try to get its economy growing again.

Economic and Monetary Affairs Commissioner Olli Rehn said Europe faced a triple challenge of "stalling growth, stressed sovereigns and still vulnerable banks".

Ministers would review options to enhance the financial firepower of the rescue fund, some of which involved leveraging with money from the European Central Bank, he said.

The debt and GDP projections illustrate how Greece has fallen into a vicious spiral of recession, falling revenues, soaring unemployment and declining consumer purchasing power.

Officials expect the next aid tranche will be paid, because the euro zone will not be ready to cope with the fallout of a Greek default until its bailout fund, the European Financial Stability Facility (EFSF), gets its new powers of market intervention ratified in the next two weeks.

Even then, however, while the 440 billion euro fund will be able to buy government bonds from the market, recapitalize banks and extend precautionary credit to sovereigns, it may not have enough cash to cope with all the financing needs.

The leveraging idea, suggested by the United States, has opponents in north European creditor countries, who fear it could lead to bigger liabilities beyond the 780 billion euros in current EFSF guarantees, or credit rating downgrades for either the AAA-rated rescue fund or its triple-A guarantors.

Among the ideas under consideration is allowing the EFSF to refinance itself at the ECB's liquidity operations for banks. The EFSF could also guarantee to cover a percentage of potential losses investors could incur in case of a hypothetical sovereign default.

Any solution, however, should not require another round of ratification, officials said, because policymakers realized how difficult and lengthy the process was given the growing opposition to bailouts in many euro zone countries.

(Additional reporting by Ingrid Melander, Dina Kyriakidou and Lefteris Papadimas in Athens, Dominic Lau and William James in London, Annika Breidthardt in Luxembourg; Writing by Paul Taylor, editing by Mike Peacock)

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Greek cabinet meets to decide more austerity steps (Reuters)

By George Georgiopoulos and Renee Maltezou George Georgiopoulos And Renee Maltezou – Sun?Sep?18, 10:32?am?ET

ATHENS (Reuters) – Greek Prime Minister George Papandreou chairs a cabinet meeting on Sunday to decide on more austerity measures to secure continued funding under an international bailout.

EU and IMF inspectors are holding a conference call with Finance Minister Evangelos Venizelos on Monday to hear what measures Greece will take to plug this year's shortfall in the budget before they release an 8 billion euro ($11 billion) loan tranche it needs by October before it runs out of money.

Papandreou canceled a planned visit to the United States on Saturday to deal with the deepening crisis at home as euro zone partners made clear further funding for the debt-ridden country would hinge on adhering to agreed fiscal targets.

"The meeting is set to examine measures from public sector layoffs to more pension cuts," said a government official on condition of anonymity.

Last week, the government blamed the shortfall on a deeper-than-expected recession and decided to put a new tax on real estate in the hope of collecting about 2 billion euros annually.

But international inspectors, known as the troika, expressed doubts this one-off tax measure would work and demanded more details on how the government hoped to catch up this year and the next.

"The troika thinks the recently announced property levy will not suffice to plug the budget hole and is pressing for measures on the spending side -- cuts in public sector wages and employment," said a second government official who asked not to be named.

The conservative New Democracy opposition has criticized the government for overtaxing the economy and driving it into a tail spin.

Its leader, Antonis Samaras, called for snap elections on Saturday saying the policy mix was wrong and was not yielding any results despite peoples' sacrifices.

"A renegotiation with our lenders to restart the economy is a condition to get out of this crisis," Samaras told a news conference on Sunday.

International lenders are also concerned with the lack of political consensus in Greece on the measures needed to emerge from the crisis.

The conservatives have been buoyed by growing public discontent after two years of austerity measures and are proposing tax cuts and growth boosting measures instead.

Papandreou's socialists have a majority in parliament but political analysts say internal dissent and public unrest, such as strikes and violent protests, may force snap elections.

Lenders have long warned against one-off measures and more taxes as a way out of the crisis shaking the euro.

They have asked for urgent reforms and privatizations to make the economy more competitive and a reduction in the bloated public sector.

($1 = 0.725 Euros)

(Writing by George Georgiopoulos; editing by Elizabeth Piper)

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Greek PM Papandreou rules out snap elections (Reuters)

ATHENS (Reuters) – Greek Prime Minister George Papandreou Saturday ruled out snap elections and said his government would succeed in bringing Greece out of the crisis by the end of his term in 2013.

Papandreou's socialist PASOK party is trailing in opinion polls and the government is facing a tough autumn as it tries to implement unpopular austerity measures to secure more EU/IMF funds.

"Citizens will judge us in 2013," Papandreou told members of his party at a conference marking its 37th anniversary.

"By then, we will have achieved bringing Greece out of the crisis and will have completed so many and important reforms," he said.

Political analysts see snap elections in the horizon and say the next few months are critical for the government as Greeks return from summer holidays to tougher austerity measures.

The government must also convince disgruntled lawmakers and an angry public that belt-tightening will pay off.

The government's failure to meet the fiscal targets set by its international lenders is also complicating Papandreou's task.

An official close to the inspectors said late Thursday that the 2011 budget deficit will be at least 8.6 percent of GDP, compared to a target of 7.6 percent.

Friday, Greece and an inspection EU/IMF team interrupted talks on a new aid tranche after disagreeing over why Athens has fallen behind schedule in cutting its budget deficit. Discussions are due to resume on Sept 14.

(Reporting by Angeliki Koutantou; Editing by Karolina Tagaris)

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Exclusive: Finland wants Luxembourg agency to hold Greek assets (Reuters)

BRUSSELS (Reuters) – Finland has proposed that Greek state assets be transferred to a Luxembourg-based holding company and held as security for new loans to Athens, according to an internal document obtained by Reuters.

The proposal, drafted in June, remains a central plank of Finnish demands for collateral in return for providing more aid to Greece. Senior euro zone officials held another conference call on Monday to try to resolve the collateral issue.

If Finland does not get its way, it may pull out of the Greek bailout, unleashing renewed trouble in financial markets.

Although small at around 1.4 billion euros, Finland's share of the new support for Greece is important because its triple-A credit rating adds weight to the 109 billion euro rescue agreed on July 21, the second bailout package Athens has received.

Demands from Helsinki for collateral have sparked requests from countries including Austria, the Netherlands, Slovenia and Slovakia for similar treatment, and threaten to spoil the euro zone's attempt to save Athens from default.

In the document, Finnish officials set out how the Greek government and its privatization agency would authorize the transfer of assets to a holding company based in Luxembourg that would be used as security for states providing assistance.

The privatization agency would own all the shares in the asset holding company, although the shares would be held in custody by a third party. Since the holding company would be based in Luxembourg, it would operate under Luxembourg law.

Such a move would prove controversial in Greece, where the government has strongly rejected suggestions of offering land or company shares as collateral for future loans. It would in effect mean Greece, which plans to raise 50 billion euros from privatization by 2015, losing sovereignty over its assets.

"The Privatisation Agency is managing the AHC (Asset Holding Company) and can use AHC in a flexible way as one vehicle to securitize, manage, develop and privatize assets," reads the Finnish plan, dated June 23 and obtained exclusively by Reuters.

Greece, which passed a law in June to set up a privatization agency to handle the sale of state-owned companies, has so far taken few steps to implement the law, meaning it may miss a target agreed with the EU and IMF of raising 1.7 billion euros from privatizations by the end of September.

MULTIPLE USE ASSETS

As well as acting as a warehouse for Greek property, such a stake in a national phone company or port, the Luxembourg vehicle would ringfence assets so they are not used for other borrowing but instead kept as security for countries offering aid. The Finnish document explains:

"If the market value of the assets of AHC does not meet the collateral requirements or the Hellenic Republic defaults on its loan obligations to the EFSF, the ownership of the shares in custody immediately transfers to the relevant member states," it says, referring to the European Financial Stability Facility, the 440 billion euro bailout fund drawn up last year.

The Finnish plan also flags a possible securitization of the assets held in Luxembourg, using cash flow generated from an airport, for example, as security for loans.

"The asset securitization would make both the valuation and the liquidation of the assets much easier," write the authors of the confidential document, which has been circulated to euro zone finance ministries in the form of a "non-paper."

The proposal is among those being discussed by euro zone officials in conference calls in recent days to try to reach agreement on how collateral can be provided to Finland, and potentially other member states, in exchange for new loans.

Earlier this year, ECB board member Juergen Stark put a value on the country's assets, which include stakes in Athens' airport, a bank, two ports, and the country's main telephone company, of 300 billion euros ($423 billion).

Tapping this wealth will be difficult politically. Talk of selling state companies prompted protests by workers worried they could lose their jobs in any privatization. Militant union members at the country's main electricity producer have warned the government not to pursue a sale.

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Moody's warns Greek default almost certain (Reuters)

By Ingrid Melander and George Georgiopoulos Ingrid Melander And George Georgiopoulos – 2?hrs?22?mins?ago

ATHENS (Reuters) – Moody's cut Greece's credit rating further into junk territory on Monday and said it was almost certain to slap a default tag on its debt as a result of a new EU rescue package.

It was the second rating agency to warn of a default after euro zone leaders and banks agreed last week that the private sector would shoulder part of the burden of a rescue deal that offers Greece more cash and easier loan terms to keep it afloat and avoid further contagion.

"The announced EU program along with the Institute of International Finance's statement implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100 percent," Moody's said in a statement.

Bank lobby IIF, which led private sector negotiations, aims to attract 90 percent investor participation in the bond exchange plan which comes on top of the EU's new 109 billion euro bailout.

Moody's cut Greece's rating by three notches to Ca, just one notch above default, to reflect the expected loss implied by the proposed debt exchanges.

Greece now has the lowest rating of any country in the world covered by Moody's, which, like Fitch last week, said it would review Greece's rating after the debt swap is completed.

"Once the distressed exchange has been completed, Moody's will reassess Greece's rating to ensure that it reflects the risk associated with the country's new credit profile, including the potential for further debt restructurings," it said.

However, whereas Fitch pledged to quickly give Greece a higher, "low speculative grade" after its bonds had been exchanged, Moody's said it could not forecast when the rating would change or how.

"It all depends how quickly the debt exchange takes place," said Alastair Wilson, Moody's Managing Director for EMEA Credit Policy. "Once we have greater visibility over that, we will reassess the credit profile quite quickly. Whether the rating will change, that's a different question," he told Reuters.

A senior EU official said on Saturday that the aim was to start a voluntary swap of privately-held Greek bonds in late August and conclude it in early September.

Greek bank shares and the broader stock market were unfazed by Moody's action. Analysts said the downgrade and the default warning were priced in and less worrying following assurances provided by the EU deal.

"The EU Council last week effectively secured Greek banks' continued access to ECB liquidity, even in the case that PSI (private sector involvement) triggers a selective default," said Platon Monokroussos, an economist at EFG Eurobank.

The government has repeatedly criticized ratings firms for their downgrades and its spokesman threatened on Monday to end its subscriptions to these agencies as the new rescue package means Greece will not issue new bonds for years.

"All governments pay a subscription to these agencies. We, I think, do not need the reviews anymore. They have no practical value," Elias Mosialos told Radio 9. "Perhaps the finance ministry should end its subscription."

CONTAGION CONTAINED ... FOR NOW

Moody's said it would take into account the possibility of a second default while reassessing Greece's rating.

"Our experience is that relatively small restructurings have often been followed by deeper defaults," Wilson said, adding that he could not say if this would be the case for Greece.

The rescue package for Greece benefits other euro zone countries by containing near-term contagion risks but it was not necessarily positive in the longer run as it set a precedent for private sector involvement in rescue deals, Moody's said.

"The support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday's announcement for creditors of Ireland and Portugal is therefore likely to be credit-neutral," it said.

The cost of insuring most peripheral euro zone government debt against default rose on Monday on market doubts that the fresh aid package for Greece agreed last week will protect bigger economies from contagion.

Standard & Poor's and Fitch rate Greece CCC, broadly in line with Moody's rating. S&P has not yet said how the EU summit deal will affect Greece's rating.

(Additional reporting by Cecile Lefort in Sydney; Writing by Ingrid Melander, editing by Mike Peacock)

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Europe nears agreement on Greek crisis bailout (AP)

BRUSSELS – Greece would get some relief on part its massive debts and a Europe-wide rescue fund would gain new powers to swiftly aid other debt-stricken countries under a sweeping deal being negotiated by eurozone leaders Thursday.

Though the deal would likely trigger a temporary default by Greece — the first ever by a euro state — it could also help the ailing country emerge from its debt hole in the longer term and shake up Europe's way of handling the crisis, by making it more proactive.

Stocks, bonds and the euro rallied sharply on hopes that the deal will be a turning point in the eurozone's 18-month debt crisis. Growing market panic has weighed on the single currency and forced already bailed out Greece, Portugal and Ireland as well as struggling Spain and Italy to make billions of euros in cuts.

A draft of the deal seen by The Associated Press said that banks and other private investors that own Greek bonds have agreed to contribute to the rescue of the country — language indicating that they will accept being paid back more slowly or at lower interest rates.

This could happen through banks trading their current bonds to Greece for new ones that mature years later. The banks could also sell their bonds back to Greece at a loss.

Ratings agencies have long warned that such measures would be seen as a form of Greek default on its loans, a first for a eurozone country and a potential cause of devastating loss of confidence in the other heavily indebted nations.

Markets appeared to be seeing the draft measures as less harmful than expected, however, fueling the rally.

"Greece is in a uniquely grave situation. This is the reason why it requires an exceptional solution," the draft says.

The draft deal, if approved, would also radically overhaul a bailout fund created last year after Greece was bailed out with euro110 billion ($156 billion) in rescue loans by the other eurozone countries and the International Monetary Fund. Like Greece, Ireland and Portugal have since found themselves increasingly unable to sell bonds with sharply higher rates demanded by investors frightened that their struggling economies would leave them unable to repay their debts.

But so far the European Financial Stability Facility could only be tapped once a country was on the brink of financial collapse and after it agreed to huge cuts and changes to the way its economy is run.

The deal would now allow the EFSF to intervene pre-emptively, before a country is in full-blown crisis mode.

For instance, countries could be given a "precautionary program," likely some form of credit line. That might allow states under stress, like Spain, to continue raising money on the markets, giving an extra assurance to investors, and could also make it easier for Ireland and Portugal to re-enter the markets once their bailout programs expire.

Money from the EFSF could also be used in some situations to recapitalize banks in countries that have not yet been bailed out, the draft says.

On top of that, the draft says, the EFSF could be authorized to buy up bonds of troubled countries on the open market, maintaining the prices of the bonds and keeping their interest rates from skyrocketing in the face of pressure from worried investors.

A eurozone official told The Associated Press that the draft was "definitely not final" and that "anything can change," speaking on condition of anonymity because of the sensitivity of the negotiations.

Even though initial market reaction to the draft deal was positive, the euro traded up 0.8 percent at $1.4371 after it had slumped earlier in the day, analysts warned that it won't constitute a turning point in the eurozone's debt travails.

"From what we can see, there are still couple of major shortcomings," Jonathan Loynes, chief European economist at Capital Economics in London, said in a note. The deal would reduce Greece's near-term financing needs, but won't significantly lower the overall debt burden, Loynes said, adding that "there is no 'shock and awe'," that would boost market confidence in the eurozone as a whole.

A major fear about a potential Greek bond default has been the potential for massive disruption to the Greek banking system. Greek banks use Greek government bonds that they own as collateral for short-term loans they receive from the European Central Bank.

That money funds the banks' day-to-day operations, including short-term loans to private businesses.

A default would render the bonds useless as collateral, causing that funding to dry up and wreaking havoc on the Greek economy.

To prevent that, the eurozone could provide some form of repayment guarantee or collateral for the new Greek bonds banks would take on, the draft says.

According to the draft, the eurozone and the International Monetary Fund are also ready to give new rescue loans to Greece, without providing a number.

Eurozone leaders also plan to ease the loan conditions for their part of the bailout, by doubling the average loan maturity for Greece to at least 15 years from 7 1/2 years currently and reduce the interest rate to 3.5 percent.

Those softer loan conditions would also apply to Ireland and Portugal.

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Clinton backs Greek strategy on debt crisis (Reuters)

ATHENS (Reuters) – Secretary of State Hillary Clinton on Sunday voiced strong U.S. support for Greece's battle to overcome its debt crisis, saying it was taking the difficult steps required for future growth.

Clinton's visit to Athens was intended to signal Washington's backing for Prime Minister George Papandreou ahead of a meeting of euro zone leaders in Brussels on Thursday to decide on a new bailout package for Greece amid fears the debt crisis could spill over to Spain and Italy.

"Americans know these are difficult days, and again we stand with you as friends and allies," Clinton said at a news conference.

"The United States strongly supports the Papandreou government's determination to make the necessary reforms to put Greece back on a sound financial footing and to make Greece more competitive economically."

While Washington believes European countries should take the lead in managing the Greek debt crisis, it has also been pushing through its membership in the International Monetary Fund (IMF) to support Papandreou's austerity plans, which have led to violent protests at home.

Clinton said Greek's politically painful plan for a medium-term fiscal strategy and bringing down its whopping debt were like "chemotherapy," but would bring results in the end.

"I am not here to in any way downplay the immediate challenges because they are real. But I am here to say that we believe strongly that this will give Greece a very strong economy going forward," Clinton said.

Greek Foreign Minister Stavros Lambrinidis said that despite the popular outrage over the deficit reduction plan, the government was determined to forge ahead.

"We believe that we shall come out of this difficulty victorious," he said. "Many on both sides of the Atlantic have bet on the collapse of Greece and then have been proven wrong. We will continue to prove them wrong."

DIGGING OUT

Greece, which has launched an austerity plan, is hoping for a second European bailout package of about 110 billion euros of extra funds to keep it financed until the end of 2014, when it is supposed to return to financial markets.

Clinton was due to meet Papandreou, President Karolos Papoulias and Finance Minister Evangelos Venizelos before heading to the Acropolis museum in central Athens to sign a cultural agreement designed to prevent trafficking of Greece's rich trove of cultural artifacts.

Despite financial headaches on both sides of the Atlantic, U.S. officials say ties between Washington and Athens are strong and that Greece has been a valuable partner in NATO-led campaigns in both Afghanistan and Libya.

The United States was also grateful to Athens for taking steps to prevent a planned activist flotilla from sailing for Gaza earlier in July, heading off what Washington feared could have been a dangerous confrontation between the pro-Palestinian activists with Israel, which had vowed to block the ships.

U.S. officials said Clinton also discussed several of Greece's diplomatic priorities including remaining strains in its relationship with Turkey and slow reunification talks on the ethnically-split island of Cyprus.

Clinton, who arrived in Greece on Saturday after a visit to Turkey which included a meeting of the international contact group on Libya, is due to depart on Monday for a visit to India that will begin the Asian segment of her round-the-world trip.

(reporting by Andrew Quinn, editing by Peter Millership)

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Euro zone makes fresh bid to tackle Greek crisis (Reuters)

BRUSSELS/BERLIN (Reuters) – Euro zone countries continued to grapple with the thorny issue of involving the private sector in tackling Greece's debt pile as they prepared for a meeting to decide support for the country next week.

"The principle of having a euro chiefs' meeting is accepted by the main players, including Germany," said one EU diplomat, adding that it was likely to happen next week despite earlier signals from Berlin that there was no rush to finalize a second package of aid.

First, however, countries have to agree how to involve private sector investors in tackling Greece's debt burden, a key demand of Germany before it signs off more support for Athens and a step the International Monetary Fund said on Wednesday must be taken.

"Comprehensive private sector involvement is appropriate, given the scale of financing needs and the desirability of burden sharing," the IMF said in its latest review of the debt-choked country.

"Greece's debt service capacity may also need to be bolstered by combining appropriate PSI and official support," IMF officials wrote, referring to private-sector involvement.

Ratings agency Fitch cited continued uncertainty about private-sector participation and foot-dragging on giving more aid to Greece, when it downgraded the country further into junk territory.

Euro zone leaders' agreement to meet followed warnings they needed to act quickly after markets were rattled by the failure of finance ministers to reach agreement earlier this week.

Italian central bank chief Mario Draghi, soon to take the helm of the European Central Bank, and Ireland's premier both said a definitive plan was needed and quickly -- echoing a strongly-worded attack from Greece's prime minister earlier in the week.

The spotlight was taken off the euro zone, at least temporarily, after the Federal Reserve Chairman Ben Bernanke said the central bank could resort to more monetary stimulus if a sluggish U.S. economy weakens further.

Ratings agency Fitch had also countered the bleak outlook in Europe following an earlier downgrade of Ireland to junk status by Moody's when it said Italy could keep its credit status by sticking to fiscal targets.

But many remained on edge after a market attack on Italy and concerns that it too could need assistance, something that would overwhelm the euro zone's existing rescue funds.

"Moody's problem is not with Ireland, Ireland's problem is with Europe," Prime Minister Enda Kenny told parliament, as the cost of insuring Irish debt climbed.

"There is no point in having a meeting that won't bring about a conclusion in a comprehensive sense to something that is not going to go away unless it is dealt with."

WRANGLING

Should the leaders meet, they will need to pin down how private owners of Greek government bonds can be persuaded to shoulder a portion of the cost of a new package for Greece, a key demand of Germany.

They will weigh up the potential impact on markets if securing such involvement is declared a debt default by ratings agencies, as expected.

But countries had appeared to be subsiding into a bout of internal wrangling and risk creating a no-win situation.

"Markets reacted very badly after euro zone finance ministers could not reach an agreement," an EU diplomat said, referring to a finance ministers' meeting on Monday. "If they cannot agree, we take the fight to the highest level."

Herman Van Rompuy, the presides over meetings of EU leaders, had originally informed ambassadors he wanted to hold a summit on Friday evening.

But Europe's biggest economic power, Germany, which one EU official said was angry about being "backed into a corner", was reluctant, pushing the date of the gathering into next week.

STRESS TESTS

Another concern of leaders are the results of stress tests of European banks.

That could have a further impact on Italy, where bank stocks and the bond market have been hit by growing concerns that the euro zone's third-largest economy could be next in line after Greece, Ireland and Portugal to suffer debt contagion.

Draghi said Italian banks would comfortably pass the tests but echoed Kenny's call for a comprehensive EU response to the spreading debt crisis.

"We have to recognize that management of the financial crisis has not gone smoothly with partial and temporary interventions," he said in a speech.

"We must now bring certainty to the process by which sovereign debt crises are managed, by clearly defining political objectives, the design of instruments and the amount of resources," he said.

There are two main proposals on the table for securing the private sector's involvement in reducing Greece's debt burden.

One would be to buy back Greek bonds at a discount. Another is to swap Greek debt for longer-dated securities with a lower coupon.

However, it remains unclear how a buy-back of Greek bonds would be financed. It could involve using the 440 billion euro European Financial Stability Facility (EFSF).

The ECB remains vehemently opposed to any Greek plan that ratings agencies would be likely to see as a default.

ECB policymaker Jens Weidmann said the EFSF should not be used to buy bonds in the secondary market and it would be unacceptable for the ECB to accept Greek debt as collateral if the country were in default.

"The money of the (EFSF) bailout should not be used for the purchase of government bonds in the secondary market," he told Die Zeit newspaper. "Containment of the crisis should not mean that we undermine our principles. We must draw a red line."

But Germany's finance ministry said funds from the euro zone's rescue mechanism could in theory be used by members of the bloc to buy back their own bonds, suggesting a shift in Berlin's stance.

(Additional reporting by Julien Toyer and Luke Baker in Brussels, and by Noah Barkin and Gernot Heller in Berlin; editing/writing by Mike Peacock)

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Europe considers Greek default, leaders to meet (Reuters)

BRUSSELS (Reuters) – European Union leaders are poised to hold an emergency summit after finance ministers acknowledged for the first time that some form of Greek default may be needed to cut Athens' debts and stop contagion to Italy and Spain.

"There will be an extra summit this Friday," a senior euro zone diplomat told Reuters, suggesting policymakers have been seized with a new sense of urgency after markets started targeting Italian assets.

A French government source said Paris was in favor, although the timing was not yet fixed, and in Spain, European Council President Herman Van Rompuy said he had not ruled out a meeting.

Earlier, Germany's finance minister had said a second Greek rescue package could wait until September after euro zone finance ministers effectively accepted that private creditor involvement meant a selective debt default was likely, despite the European Central Bank's vehement opposition to such a move.

"We have managed to break the knot, a very difficult knot," Dutch Finance Minister Jan Kees de Jager told reporters.

Asked about whether a selective default was now likely, he replied: "It is not excluded any more. Obviously the European Central Bank has stated in the statement that it did stick to its position, but the 17 (euro zone) ministers did not exclude it any more so we have more options, a broader scope."

Participants said a buy-back of Greek debt on the secondary market and a German proposal for a bond swap for longer maturities were under consideration after a complex French plan to roll over bonds made no headway.

Both would likely be regarded by ratings agencies as a default, or at best a selective default, which although it would not necessarily cover all Greek debt and could be lifted quickly, would have major repercussions for financial markets.

The Institute of International Finance, the lobby group representing private creditors, said the EU and IMF needed to deliver a plan for Greece, including a debt buyback, within days to avoid markets "spinning out of control.

The increased likelihood of some form of default, and a lukewarm response from the IMF, hit European bank stocks and debt markets and propelled the euro sharply lower against the dollar although markets settled later.

Ten-year bond yields in Italy, the euro zone's third-largest economy, shot above six percent for the first time since 1997 but then subsided to around 5.7 percent, still at a level which bankers say will put heavy pressure on finances.

Borrowing costs at an Italian 12-month bill sale surged to their highest since the 2008 financial crisis, putting a Thursday bond auction firmly in focus.

There is now acute concern about contagion to Italy, where political tensions between Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti have exacerbated concerns, and to Spain, the euro zone's fourth largest economy.

In Rome, Berlusconi tried to calm fears Italy could be swept into full-scale crisis, pledging to accelerate debt-cutting measures and run a primary surplus this year.

Willem Buiter, chief economist at Citi and a former UK central banker, said there was a clear spread beyond Greece, Ireland and Portugal, the three nations bailed out so far.

"We're talking a game changer here, a systemic crisis," he said. "This is existential for the euro area and the EU."

The euro fell to a four-month low against the dollar before recovering, in part because IMF Managing Director Christine Lagarde said the lender and its EU partners were not yet ready to discuss terms for a second Greek bailout.

"Nothing should be taken for granted," she told reporters in Washington.

FUNDAMENTAL SHIFT

While the finance ministers were not explicit about how they planned to tackle Greece's debt, saying only that proposals would be discussed "shortly," they acknowledged that the debt pile -- at around 160 percent of GDP -- had to be reduced.

"We stress the need to make Greek debt more sustainable," Jean-Claude Junker, the chairman of the Eurogroup of finance ministers, said after more than eight hours of talks on Monday.

Economists regarded Junker's words and the comments from other finance ministers as a fundamental shift.

"The euro area now seems to be moving more explicitly toward debt relief via EFSF-funded purchases of secondary market debt," JPMorgan economist David Mackie wrote in a research note, referring to the euro zone's 440 billion euro emergency loan fund, which as it stands would not have enough resources to bail out Italy.

"Greece will need debt relief at some point, but it is not clear it is much of a help now. More likely the shift toward debt relief is intended as an attempt to limit contagion."

The decision to call an extra leaders' summit helped counter negative market reaction to an apparent absence of hurry, after German Finance Minister Wolfgang Schaeuble said there was time to wait on Greece, with no new tranche due until September.

That lack of urgency prompted stern criticism from Greece's prime minister but the finance ministers did hint at the prospect of more fundamental steps to come.

"Ministers stand ready to adopt further measures that will improve the euro area's systemic capacity to resist contagion risk, including enhancing the flexibility and the scope of the EFSF, lengthening the maturities of the loans and lowering the interest rates, including through a collateral arrangement where appropriate," they said in a statement.

There was no indication, though, that they had broken a stalemate over how to make banks, insurers and other funds share the cost of additional funding for Athens.

A senior member of Germany's governing coalition acknowledged, however, that a debt restructuring was coming.

"We just need to ensure that it's as orderly a process as possible," he said, adding that it could come in the autumn.

Germany, the Netherlands, Finland and others want the private sector to provide at least 30 billion euros in a new package for Greece that could total 110 billion euros.

(Additional reporting by John O'Donnell, Leigh Thomas, Dan Flynn in Brussels, Silvia Westall in Vienna, Huw Jones in London, Stephen Brown in Berlin, Lesley Wroughton in Washington and Milan/Rome bureaus, editing by Mike Peacock)

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Eurozone mulls Greek options, fears spread to Italy (Reuters)

BRUSSELS (Reuters) – EU finance officials will discuss a range of options for Greece's intractable debt crisis on Monday, galvanized by the growing threat of contagion to Italy, the euro zone's third-largest economy.

A senior European Union source told Reuters the Eurogroup of 17 euro zone finance ministers meeting later would discuss the possibility of buying back Greek debt or the private sector swapping holdings for longer-dated maturities.

If so, it suggests a French plan that would have involved private sector creditors rolling over around 70 percent of their Greek debt into 30-year bonds and other AAA-rated securities is losing favor and other options are back under the microscope.

Germany, the Netherlands, Austria and Finland are determined that banks, insurers and other private holders of Greek government bonds should bear a chunk of the costs of a second Greek bailout, which is expected to total 110 billion euros.

But after weeks of negotiations with bankers, there has been next to no progress on agreeing a formula acceptable to all sides.

As the French plan has faltered, Berlin has revived a proposal to swap Greek bonds for longer-dated debt that would extend maturities by seven years. Proposals to buy back Greek bonds and retire them have also been floated.

"We need to find a way to have some guidelines today on the private sector involvement and the solution for Greece," Belgian Finance Minister Didier Reynders told reporters. "That's the real issue today, I'm sure."

The senior EU source said the Eurogroup would task technical groups with working on the two options -- bond buybacks and a debt rollover.

"There is a strong possibility that a new Eurogroup meeting will be called at the end of July, to sign off on the solutions," the source said.

Both those schemes would likely be regarded by ratings agencies as a default, or at best a selective default, which could have profound repercussions for global financial markets.

The European Central Bank insists it will not accept anything that is termed a default, a position Germany also holds even if some policymakers may be edging closer to effectively condoning a default to achieve a write-down in the value of Greek debt to make its debt mountain more sustainable.

"We do pursue a voluntary basis but it has to be substantial private sector involvement. That's our commitment and also our parliament that demands it," Dutch Finance Minister Jan Kees De Jager said.

In a buy-back, the bloc's European Financial Stability Facility (EFSF) bailout fund might buy Greek bonds from the market, or lend Greece money to do so. Officials say that would require changes to the EFSF's rules which would need the backing of national parliaments -- a further potential obstacle.

ITALY FOCUSING MINDS

Policymakers have been seized with a new sense of urgency after Italy came under market attack last week, fearing any further delay in putting together a second Greek package could poison investor confidence in weak economies around the region.

After talking by phone to Italy's Silvio Berlusconi, German Chancellor Angela Merkel said Rome needed to demonstrate it was undertaking the budget reforms needed to restore confidence and she was confident that it would do so.

Herman Van Rompuy, the president of the European Council, met ECB President Jean-Claude Trichet and Jean-Claude Juncker, the chairman of the Eurogroup, for talks in Brussels ahead of the euro zone finance ministers' gathering.

Van Rompuy's spokesman described the meeting, which European Commission President Jose Manuel Barroso and EU economic and monetary affairs commissioner Olli Rehn also attended, as a "coordination, not a crisis meeting."

He said Italy was not on the agenda but senior EU sources said it would be impossible not to discuss it following a large sell-off in bonds and stocks that the Italian media have dubbed "black Friday."

The cost of insuring Italian debt against default jumped to a record high on Monday, the 10-year yield spread over German debt widened to a euro-era high of 268 basis points and bond yields neared the 5.5-5.7 percent area which bankers say will start putting heavy pressure on Italy's finances.

The sell-off has increased fears that Italy, with the highest sovereign debt ratio relative to GDP in the euro zone after Greece, could be next to get dragged into crisis. If that came to pass, the euro zone's existing rescue mechanism, the EFSF, would have insufficient funds to help.

Austria's Finance Minister Markia Fekter said ministers wanted to quiz Italy about how it was handling the situation.

"We have a Eurogroup meeting today and tomorrow Ecofin. We will (discuss) the IMF decisions and we will also have questions for the Italian minister there," she told reporters.

The market pressure is due in part to Italy's high sovereign debt and sluggish economy, but also due to concern that Prime Minister Silvio Berlusconi may be trying to push out his long-time finance minister, Giulio Tremonti, who has promoted deep spending cuts to control the budget deficit.

"We can't go on for many more days like Friday," a senior ECB official told Reuters. "We're very worried about Italy."

German newspaper Die Welt quoted an unnamed ECB source as saying the EFSF may have to be doubled in size to 1.5 trillion euros if it is to be capable of coming to the aid of Italy.

(Additional reporting by John O'Donnell in Brussels, Silvia Westall in Vienna, Stephen Brown in Berlin and Milan/Rome bureaus, writing/editing by Mike Peacock)

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New Greek aid package awaits private sector buy-in (Reuters)

ROME/FRANKFURT (Reuters) – International bankers and European Union officials made no progress on Thursday in securing a private sector contribution for a second bailout of Greece and bond yields climbed on concern about the scheme.

The managing director of the Institute of International Finance (IIF), a group representing around 400 banks and financial organizations, met representatives from the European Central Bank, the Greek government and the euro zone in Rome to try to break a deadlock over how private creditors might voluntarily maintain their exposure to Greek sovereign debt.

It was the latest in a series of meetings in recent weeks, but there is little sign of the parties reaching a deal. Thursday's meeting, which explored a possible buyback of Greek debt, broke up with no conclusion.

To avoid a debt default by Greece, euro zone finance ministers are trying to put together a second international bailout by mid-September. A private sector debt rollover, in which investors would buy new Greek bonds as existing ones matured, is an important part of the new rescue plan.

Until Thursday, efforts had focused on a French proposal to roll over up to 70 percent of Greek debt maturing before the end of 2014, with a portion of that going into new 30-year Greek bonds that would be guaranteed by other AAA securities.

But attention has now shifted to the possibility of buying back Greek debt, or switching existing Greek bonds for longer-dated ones, which could trigger a default.

In a statement, the IIF said participants had discussed "debt buy-back approaches," but did not go into details.

Reflecting fading hopes for a breakthrough, one banking source commented before the meeting: "The circus moves to Rome."

Partly because of the insistence of the European Central Bank, governments and banks have been trying to put together a debt rollover that would not prompt credit rating agencies to declare a default -- even a limited or "selective default." But that is proving very difficult.

Asked about such a possibility at a news conference after the ECB raised euro zone interest rates by a quarter of a percentage point to 1.5 percent, President Jean-Claude Trichet said: "We say 'no' to selective default or credit event."

Dutch Finance Minister Jan Kees de Jager told a Dutch newspaper on Thursday that if pressure needed to be put on the private sector to ensure its involvement was substantial, then that would just have to be done, despite the implications.

"I think we need to accept that a voluntary contribution is not realistic," he told Het Financielle Dagblad. "If a compulsory contribution from the banks leads to a short and isolated (credit) rating event, then that is not so bad."

BOND YIELDS RISE

Yields on government bonds of indebted euro zone states rose to euro-era highs on Thursday because of concern that any scheme to have private investors pay in a rescue of Greece could be applied to the debt of other countries too.

Portuguese two-year bond yields rose more than a percentage point after rising by more than 4 percentage points on Wednesday following Moody's downgrade of Portuguese debt to "junk." Irish 10-year bond yield jumped more than 0.7 percentage point to 13.42 percent. The euro weakened marginally to 1.4280.

In Frankfurt, the ECB said its rate hike was aimed at curbing inflation, but the move will also increase borrowing costs and pressure on banks in Greece, Ireland and Portugal, as well as other at-risk euro zone states such as Spain.

Trichet said the bank had decided to suspend Portugal's requirement to post collateral for credit operations, a move to soften the burden on Lisbon.

Despite pressure on Spain, Madrid showed it could still fund itself in the markets at affordable rates, attracting strong demand on Thursday for 3 billion euros of three- and five-year bonds, helped by Spanish banks which traditionally purchase their own country's debt.

BAILOUT

The next bailout of Greece, which follows agreement in May 2010 on 110 billion euros of emergency loans, is expected to total around 115 billion euros ($164 billion) and aim to fund Athens until late 2014, when it should return to markets.

Of the total, euro zone governments want the private sector to provide 30 billion euros via the debt rollover. Greece itself would provide a further 30 billion euros to the package by selling state assets, and the remainder would come from the EU and the International Monetary Fund.

Euro zone finance ministers will discuss the outlines of the new plan in Brussels on July 11, but no firm decisions are expected because the private sector's role remains unclear.

In Berlin, Jean-Claude Juncker, the chairman of the 17-member Eurogroup, added his voice to criticism by EU leaders of ratings agencies following Moody's downgrade, saying he favored the creation of a European credit ratings body.

Michel Barnier, the European commissioner for financial regulation, has suggested the licenses of ratings agencies operating in Europe could be revoked if they don't adhere to new, stricter EU rules on their operations.

(With additional reporting by Frankfurt bureau, DeepaBabington in Rome, Martin Santa in Bratislava; writing by LukeBaker; Editing by Andrew Torchia/Ruth Pitchford)

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Greek premier hails tight austerity victory (AFP)

ATHENS (AFP) – Greek Prime Minister George Papandreou hailed Thursday a parliamentary vote to introduce fresh austerity measures, despite riots in the streets, in a bid to avoid national bankruptcy.

"We have fought and won a difficult battle," Papandreou said as he opened cabinet talks on additional government reforms, after two days of voting to pass the 28.4-billion-euro ($40 billion) fiscal plan despite rioting around the Athens parliament.

"We still have very tough fights ahead at this crucial point to get out of this crisis, and change this country," he added, after seeing his parliamentary majority narrow ahead of fresh protests called for Syntagma Square later Thursday.

The European Union said Greece had now met the conditions set by the other euro currency nations to receive a blocked 12-billion installment from a joint bailout agreed with the IMF last year.

"In very difficult circumstances, it was another act of national responsibility," said EU president Herman Van Rompuy, in reference to running battles between hardcore protesters hurling firecrackers and police firing tear gas throughout a 48-hour general strike.

With government cuts accelerating across a nervous Europe, the final count gave Papandreou 155 votes, to 136 voices against.

However, he was on much less secure ground when it came to the legal detail concerning the package of reforms to be implemented through 2015.

Opposition conservatives backed privatisation, spending cuts and plans to lease out government-owned real estate -- but not a heavier tax burden for all, the cause of most of the anger on the streets.

A new rebel among the governing Socialists also voted no on individual clauses, although the whole package does go forward.

Nevertheless, the voting crossover matters because annual budget votes will still be required to drive through plans that protesters say will only result in more slippage until the Greek government is replaced.

Austerity has swept through Europe with the debt crisis refusing to clear, and the pressure is firmly on to prevent it impacting all countries with high debts -- including the United States -- on financial markets.

Eurozone finance ministers meet in Brussels on Sunday, when they can start the real job of drawing up a second bailout of a similar size to last year's 110-billion-euro rescue.

The volume to be contributed by private banks has caused ructions among EU partners, which Belgium's Finance Minister Didier Reynders said are unlikely to be resolved before further July 11 talks, even though Germany announced an agreement with banks to roll over some 3.2 billion euros in Greek bond investments.

Papandreou's finance minister Evangelos Venizelos raised another problem by saying "countries like Finland," a gold-plated eurozone economy influential in Brussels, also want Athens to put up collateral.

He said Helsinki "wants guarantees over and above those compatible" for Athens with EU rules of solidarity.

Greeks fear real estate or even islands being sought as lose-able collateral for government finance, as with home loans.

Greece's debt pile is variously put at 330-350 billion euros.

Outgoing European Central Bank figures laid bare divisions on how fast to cut: president Jean-Claude Trichet said "corrections" are neeeded to create jobs, whereas executive board member Lorenzo Bini Smaghi warned of "unprecedented masochism."

In downtown Athens Thursday evening, protesters known as Indignants were still camped out on Syntagma Square and rallies were called for mid-evening amid a nationwide 24-hour port strike.

The government earlier announced an inquiry into alleged police brutality during the rioting on Wednesday when blocks of downtown Athens resembled a battlefield for hours.

Blanketed by tear gas, bat-wielding hardcore elements fought sometimes alongside police hurling rocks and tear gas into enclosed spaces while medics carried bloodied casualties away.

"I don't understand why the police used so much tear gas," said an American tourist called Adam, after Amnesty International criticised "excessive" use of force.

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Greek lawmakers endorse austerity despite violence (Reuters)

ATHENS (Reuters) – Greece's parliament approved deeply unpopular austerity measures despite worsening street violence on Wednesday, in a vote vital to secure international aid and prevent the euro zone's first sovereign debt default.

Lawmakers passed a five-year package of spending cuts, tax rises and state asset sales by a comfortable margin of 155 votes to 138 in a roll-call vote, handing a victory to embattled Prime Minister George Papandreou.

"We must avoid the country's collapse at all costs. Now is not the time to step back," the Socialist premier told lawmakers just before the vote.

The solid margin suggested the government should be able to push through laws implementing specific budget measures and asset sales on Thursday, clearing the last obstacle to obtaining 12 billion euros ($17.3 billion) of emergency loans.

But with the country on the brink of bankruptcy and social unrest mounting, it is unclear whether the government can stick to the tight schedule imposed by the European Union and the International Monetary Fund to implement the austerity steps, even if it wins all this week's parliamentary votes.

The full pain of pay and benefit cuts and sharp tax increases has yet to be felt, and public anger is boiling.

Outside parliament, there were clashes between stone-throwing masked youths and riot police, who fired clouds of teargas from behind steel crash barriers to keep rioters at bay.

One group of anarchists armed with staves and iron bars attacked finance ministry offices just off Syntagma Square, smashing windows at the entrance and on higher floors. A post office on the ground floor of the ministry building was set on fire, sending acrid grey smoke billowing into the sky.

In cat-and-mouse clashes with police, rioters erected makeshift barricades with benches, chairs and garbage bins on the fringes of the square, where thousands of peaceful protesters demonstrated against the austerity plan.

Chancellor Angela Merkel of Germany, Europe's reluctant paymaster and the main contributor to the bailout of Greece, was quick to praise the "brave" vote. But Finance Minister Wolfgang Schaeuble stressed the importance of "implementing these (measures) with resolve in the coming weeks, months and years."

The presidents of the European Council and the European Commission, Herman van Rompuy and Jose Manuel Barroso, said in a joint statement that Greece had taken "a vital step back -- from the very grave scenario of default."

However, many economists and investors still expect Greece to default in the medium term because its 340 billion euro pile of sovereign debt is so huge, about 150 percent of the country's annual economic output. A senior German ruling coalition politician, Free Democratic floor leader Rainer Bruederle, said on Wednesday that a debt restructuring was inevitable.

Expectations for a positive vote and progress in talks between banks and euro zone governments on a rollover of privately held Greek debt lifted the euro and global stocks on Wednesday. Prices of bonds issued by the zone's weaker states rose.

But markets then fell back slightly after news of parliament's decision.

"This is logical and may continue over the next couple of hours and days as markets will quickly realize that this is only a first step on the road to recovery," said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets.

"We still expect a hot, nervous and volatile summer."

ROLLOVER

Despite a threat by trade unions staging a 48-hour general strike to prevent lawmakers entering the colonnaded parliament building, deputies were able to reach the chamber. Strikes and sporadic violence have not blown the government off course so far, but its approval rating has plunged in recent months.

Only one deputy in the ruling PASOK party voted against the plan and was immediately expelled from the party by Papandreou. At least one opposition deputy broke ranks with the main conservative New Democracy party and voted "yes."

PASOK now holds 154 seats in the 300-member chamber and it was helped on Wednesday by the abstention of a small center-right splinter group of five deputies led by former foreign minister Dora Bakoyanis.

The EU and the IMF have insisted Greece must adopt the austerity plan, which seeks to save the government 28 billion euros, in order to receive its next slice of aid. Without the money, Athens would run out of cash within weeks.

In May last year Greece signed a 110 billion euro bailout deal with the EU and the IMF, which later jumped in to keep Ireland and Portugal afloat as the euro zone reeled from high government debt in the wake of the global financial crisis.

If Greece's fiscal legislation passes on Thursday, euro zone finance ministers meeting in Brussels on Sunday are expected to agree to release their part of the next aid tranche, with the IMF following on July 5.

Attention will then switch to putting together a second and longer-term rescue package for Greece of about the same magnitude as the initial 110 billion euro bailout.

The new program would involve some 30 billion euros in private-sector participation via a "voluntary" rollover of maturing debt, a similar sum from Greek privatization revenues, and an expected 55 billion euros in new official funding.

Banking sources said politicians and commercial bankers were confident that credit rating agencies would accept a French proposal for a voluntary private sector rollover of Greek debt without triggering a default or a payout of credit insurance.

The agencies have made no public comment on the plan, details of which are still under negotiation.

Euro zone banks and insurers are considering a scheme under which private bondholders would reinvest half of the proceeds of maturing Greek debt in new 30-year bonds paying 5.5 percent interest plus a bonus linked to Greece's economic growth rate.

Of the other half, 30 percent would be paid back to investors in cash and 20 percent invested in a "guarantee fund" of zero-coupon AAA securities with deferred interest that might be issued by the euro zone's bailout fund, officials and banking sources said.

In addition to the rating agencies, the rollover scheme will need the approval of the European Central Bank, and ECB policymaker Juergen Stark rejected on Wednesday any scheme that involved EU guarantees of bonds, saying it would breach European treaty rules.

Asked about a scenario in which banks would exchange their Greek bonds for new paper guaranteed by EU states -- an approach similar to the "Brady bonds" used in Latin America in 1989 -- he said: "This instrument is disqualified.

French banks had the largest exposure to the Greek economy, both the public and private sectors, at the end of 2010 with over $56 billion, data from the Bank for International Settlements shows. The next most exposed country is Germany.

(Additional reporting by George Georgiopoulos, Daniel Flynn and James Mackenzie in Athens, Philipp Halstrick and Ed Taylor in Frankfurt, Stephen Brown in Berlin, and Atul Prakash and Jeremy Gaunt in London; writing by Paul Taylor; editing by Janet McBride and Andrew Torchia)

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Banks study Greek debt rollover ahead of key vote (Reuters)

By George Georgiopoulos and Emmanuel Jarry George Georgiopoulos And Emmanuel Jarry – 1?hr?32?mins?ago

ATHENS/PARIS (Reuters) – France offered a radical solution on Monday for banks to roll over holdings of Greek debt for 30 years as the Athens government fought to get backbench rebels to back a crucial austerity plan to avert bankruptcy.

With depositors fleeing Greek banks in growing numbers and financial markets watching anxiously, President Nicolas Sarkozy told a news conference in Paris that French banks had reached a draft agreement with the authorities on a voluntary rollover of maturing bonds.

"We concluded that by stretching out the loans over 30 years, putting (interest rates) at the level of European loans, plus a premium indexed to future Greek growth, that would be a system that each country could find attractive," he said.

The plan, drafted by French bankers, was put to a meeting of international bankers and European Union officials with the International Institute of Finance (IIF) in Rome on Monday but no decision was taken, an Italian Treasury official said.

In a sign of ebbing confidence that Greece can avoid default on its 340 billion euro debt mountain, Moody's said Greek banks had lost about 8 percent of private sector deposits so far this year as customers burned their savings due to unemployment, transferred funds abroad or bought gold.

French government sources said under an outline deal, banks would reinvest 70 percent of the proceeds when Greek bonds fall due in 2011-14 and cash out the rest. Of the amount reinvested, 50 percent would go into the new 30-year bonds and 20 percent would go into zero-coupon AAA bonds with deferred interest.

The new bonds would be placed in a Special Purpose Vehicle, effectively removing Greek debt from the balance sheets of participating banks, the source said.

Private banking sources said the new bonds could be guaranteed by the euro zone's rescue fund (EFSF) or the European Investment Bank. Banks would hold equity in the SPV instead.

However, a French government source described the solution, proposed by French bankers, as "a sort of private Brady bond without a public guarantee," referring to a 1989 swap of Latin American debt for tradeable securities, some of them guaranteed, proposed by then U.S. Treasury Secretary Nicholas Brady.

German banks voiced interest in the "French model" although Deutsche Bank chief Josef Ackermann said it was only one of several solutions being considered and it was unclear whether any satisfactory proposal could be found.

"Political leaders expect a solution by the end of the week but we should not rush it," Ackermann told Reuters Television in an interview. "It is important to have a good solution. The issues are complex and need to be discussed."

Any new financial rescue for Athens, including official lending and private sector participation, depends on the Greek parliament approving this week a five-year austerity plan and legislation to implement structural reforms and privatizations.

REBELS PRESSED

Greek Finance Minister Evangelos Venizelos met ruling socialist party (PASOK) rebels in Athens to push them to toe the line in parliamentary votes on Wednesday and Thursday, where a defeat could plunge the country into default.

Greece's conservative opposition has rejected calls for national unity, forcing Prime Minister George Papandreou to rely on his slim parliamentary majority to push through a painful mix of spending cuts, tax hikes and state selloffs.

However with Greece stuck in deep recession, at least three PASOK deputies have expressed serious reservations or outright opposition to a plan they say will crush any hope of growth for years to come and it is unclear how the numbers will play out.

Without parliamentary approval for the measures, which have caused a wave of strikes and demonstrations, the European Union and International Monetary Fund say they will not release the fifth tranche of the 110 billion-euro bailout agreed last year.

If the 12 billion-euro tranche is not forthcoming, the Greek government, which has been shut out of financial markets because of the ruined state of its public finances, will run out of money within weeks, probably triggering a Europe-wide crisis.

"If it is Greece alone, that's already big," Ackermann said. "But if other countries are drawn in through contagion, it could be bigger than Lehman," he said, referring to the disastrous 2008 collapse of Wall Street investment bank Lehman Bros.

Three euro zone sources in Brussels said EU officials were working on a contingency plan for Greece if its parliament rejects an austerity program and the country cannot receive the next installment of EU/IMF emergency loans.

The fallback plan, distinct from the French rollover ideas, involves ways to ensure Greece gets the liquidity needed to avoid default if the next 12 billion euro tranche of aid cannot be paid out by mid-July, the sources said.

PREPARATIONS

The debate in Athens is set to begin on Monday evening with an initial vote on the framework austerity package due on Wednesday, and lawmakers then voting on Thursday on a separate bill containing specific steps to implement it.

Defections over the past 13 months have cut Papandreou's support in the 300-member parliament to 155 seats, meaning a handful of votes could decide the issue, which may be further complicated if one bill passes and the other does not.

In an interview with Spanish daily El Mundo on Sunday, Deputy Prime Minister Theodore Pangalos said he believed the first vote would pass but he was less confident about the second implementation bill.

"That's where we may have problems," he said. "I don't know whether some of our legislators will vote against it."

Venizelos was due to meet wavering deputies throughout Monday in a last-ditch bid to ensure the votes pass after German ministers warned that Europe had to make plans for the event of a defeat which would block the next tranche of aid.

"(Rejection) isn't Plan A, or the most likely outcome but the euro zone and its financial sectors need to make preparations," Deputy Finance Minister Joerg Asmussen told a conference on Monday.

Progress in the rollover talks cooled demand for safe-haven bonds on Monday but the premium investors demand to hold Greek debt rather than benchmark German Bunds widened by a further 20 basis points to 1,432 basis points.

BAILOUT INSUFFICIENT

With the current 110 billion bailout insufficient to keep Greece going, European leaders are working on a further package of a similar size including a contribution from private banks which would agree to a voluntary rollover of their Greek debt.

Whether such a deal will be enough to stave off problems in the longer term remains uncertain. Many investors and economists believe that even if the austerity package is passed this week, it will merely delay an inevitable restructuring or default.

With the fate of both the existing aid plan and the new package dependent on this week's vote, major rallies are planned by the protesters who have been occupying Syntagma Square outside the Greek parliament in Athens for the past month.

Public anger at the political class has been fueled by Greece's worst recession since the 1970s, a youth unemployment rate of more than 40 percent and public finances that have been shattered by a debt equivalent to some 150 percent of gross domestic product.

The powerful public sector union ADEDY and its private sector equivalent GSEE are due to hold a 48-hour strike on June 28 and 29, that will hit public transport, telecoms, the post office and many hospitals.

Many companies, including the main electricity group PPC which is slated for partial privatization next year, have already started rolling stoppages.

On Monday, protesters hung a huge banner off the Acropolis, the ancient rock outcrop which dominates Athens, proclaiming: "People have the power, they never surrender."

(Additional reporting by Stephen Slater in London, Luke Baker and Julien Toyer in Brussels, Nick Vinocur in Paris, Stefano Bernabei and Gavin Jones in Rome; Writing by James Mackenzie and Paul Taylor, editing by Paul Taylor/Janet McBride)

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Greek rebel lawmakers may block austerity: deputy PM (Reuters)

ATHENS (Reuters) – Greece's deputy prime minister warned on Sunday that rebel lawmakers may block some reforms sought by international lenders, though parliament will probably back an overall austerity package this week to avert national bankruptcy.

Adding to Socialist Prime Minister George Papandreou's dire problems, the conservative opposition rejected appeals from the government and senior European Union politicians to vote in favor of the five-year plan.

Parliament is due to start debating on Monday the programme of tax increases and spending cuts worth 28 billion euros. Papandreou needs parliamentary approval this week to secure the next payment under a 110-billion euro EU/IMF bailout.

Deputy Prime Minister Theodore Pangalos told Spanish newspaper El Mundo he was optimistic about overcoming discontent in his PASOK party to win a first round of general votes on tax and spending targets and the creation of a privatisation agency.

But he was more cautious about whether the government could push through further enabling legislation on individual budget measures and privatisation of specific state assets.

"I think the package of short and medium-term measures with which we basically hope to establish the framework to undertake reforms will be approved without difficulty," Pangalos told the newspaper in the interview published on Sunday.

Approval of specific laws to enact painful fiscal reforms and privatisations may be more difficult to achieve, he said.

"That's where we may have problems. I don't know whether some of our legislators will vote against it. It's possible."

Without the next 12-billion euro tranche of funding from the IMF and European Union, Greece faces the prospect next month of becoming the first euro zone country to default, sending shockwaves through a fragile global financial system.

But many Greeks who have lost jobs or seen their real income decline by nearly one-fifth over the last two years have reacted angrily to measures they say fail to target wealthy tax evaders whom they regard as responsible for Greece's plight.

Papandreou's PASOK party has seen its slender majority whittled down by five defections over the last 13 months, leaving it with 155 seats in the 300-member parliament.

In a rare piece of good news for Papandreou, one of the two PASOK legislators who announced they would vote against the package appeared to be wavering on Sunday after holding talks with Finance Minister Evangelos Venizelos at the weekend.

"One moment I veer toward a 'no', the other toward a 'yes'. I will make a last-minute-decision," Thomas Robopoulos told Reuters. A third Socialist MP has said he will support the deal only if Venizelos gives him assurances on certain measures.

NATIONAL STRIKE

With Greece unable to return to international bond markets next year, as foreseen under its EU/IMF programme, European leaders are working on a new bailout of a similar size, including a contribution from private sector banks which would agree to a "voluntary" rollover of their holdings of Greek debt.

Euro group president Jean-Claude Juncker, the prime minister of Luxembourg, said on Sunday that the size of this private sector contribution would be discussed at a euro zone finance ministers' meeting in early July.

Ramping up pressure on the government, unions have called a two-day national strike from Tuesday. Many companies, including the main electricity group PPC which is slated for partial privatisation next year, have started rolling stoppages.

Pangalos, who after a cabinet reshuffle this month shares his deputy premier's title with Venizelos, said he believed the conservative opposition would vote in favor of some measures.

But New Democracy leader Antonis Samaras turned a deaf ear to the appeals from home and abroad to support the package, saying the painful measures would only deepen Greece's worst recession in 37 years.

"You can't ask for more taxes in an already overtaxed country, in a market that has been sucked dry, with economic activity at zero and a huge recession," he said in a statement.

Greek ministers and policymakers had urged legislators to approve the austerity package, adding to calls from European leaders to avoid a crisis in the 17-member euro zone.

German Finance Minister Wolfgang Schaeuble urged the Greek parliament to approve the measures, warning that the EU would not relax this condition for disbursing the next aid tranche.

"The stability of the entire euro zone would be in danger and we would need to quickly ensure that the risk of contagion for the financial system and other euro area countries would be contained," he told German Sunday newspaper Bild am Sonntag.

Venizelos, a Socialist party baron given the finance portfolio in the cabinet reshuffle, clinched the agreement of EU and IMF inspectors on Thursday to a raft of measures which he hopes can put government finances back on an even keel after it failed to meet targets under its international programme.

The steps include a one-off solidarity levy on income, a rise in heating fuel tax and the introduction of income tax even for low earners on wages of 8,000 to 12,000 euros a year.

A peaceful crowd of around 1,000 people gathered on Sunday in Syntagma square outside parliament, which was protected by a line of riot police.

With youth unemployment running at around 40 percent, many of those who have taken to the streets in protest or camped in Syntagma over the last month are young people who fear the measures will worsen their dim economic prospects.

"The choice is not between voting for the measures or defaulting, but between economic and social bankruptcy on the one hand and growth and social cohesion on the other," said the Left Coalition, a small opposition party, in a statement.

(Additional reporting by Tracy Rucinski in Madrid; editing by Ralph Boulton)

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Greek ministers appeal to MPs to back austerity plan (Reuters)

ATHENS (Reuters) – Greek ministers urged wavering members of the ruling Socialist party on Saturday to do their duty in a knife-edge vote in parliament next week and back painful austerity measures that lenders demand as the price for fresh bailout loans.

Finance Minister Evangelos Venizelos offered to talk to any MP who might have concerns. "I believe that the sense of responsibility will ultimately prevail, the God of Greece is great," he said on TV station Alter.

With Prime Minister George Papandreou's majority down to a handful of votes, one deputy from his PASOK party said on Friday he would vote against the measures, joining another party rebel who announced his opposition earlier this month.

The mix of spending cuts, state selloffs and tax hikes demanded by international lenders to reduce Greece's enormous public debt has caused bitter resentment among ordinary Greeks, who have taken to the streets in daily protests.

A two-day general strike is planned next week to coincide with the votes, following a rolling series of strikes at companies including Greece's dominant electricity producer PPC, which is slated for privatisation next year.

Unable to borrow on the markets because of the ruined state of its public finances, Greece depends on international support to avert bankruptcy in the next few days, an event that could plunge the global economy into turmoil.

But international lenders have demanded a clear commitment to reform and if parliament fails to back either of two key austerity votes on June 29 and 30, the EU and the IMF may refuse to release a vital 12-billion euro funding that Greece needs immediately or to approve a new bailout package.

Athens accepted a package of 110 billion euros of EU/IMF loans in May 2010 but now needs a second bailout of a similar size to meet its financial obligations until the end of 2014, when it hopes to return to capital markets for funding.

Justice Minister Miltiadis Papaioannou urged his fellow MPs to back the unpopular measures. "They must shut their ears to all the criticism they are hearing and do their duty," he said in an interview on TV station Mega.

Despite heavy pressure from European leaders including German Chancellor Angela Merkel, the conservative New Democracy opposition party, has refused to support the package, meaning two or three votes either way could decide the outcome.

Papandreou's government now has 155 seats in the 300-strong parliament. Austerity measures have cost the Socialists five defections since their October 2009 election victory with a majority of 160 MPs.

The embattled prime minister last week sacrificed his previous finance minister, George Papaconstantinou, in a reshuffle to smooth the passage of the austerity plan but opinion polls still show him trailing the opposition.

Papandreou's MPs solidly backed the new government in a vote of confidence on Wednesday. But doubters maintain their opposition to higher taxes and the planned sale of shares in some state-controlled companies.

"Shops are shutting down every day and we are taking anti-growth measures," party maverick Thomas Robopoulos, a car dealer from Greece's second city, Thessaloniki, and one of the few businessmen in parliament told Reuters.

Austerity measures have pushed Greece into its deepest recession in 37 years, with GDP declining more than 4 percent last year. Unemployment has surged to a record 16.2 percent in March with youth jobless rates now at 43 percent.

Venizelos acknowledged that many of the measures he agreed with inspectors from the EU and the IMF late on Thursday were unfair and harsh, but said they were necessary to stave off default.

(Editing by Alistair Lyon)

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Banks move closer to deal on Greek bailout (Reuters)

ATHENS/FRANKFURT (Reuters) – Banks and policymakers moved closer to a deal on Friday to help Athens secure funds ahead of a parliamentary vote on austerity next week that Greek Prime Minister George Papandreou must win to avert default.

Despite a refusal by the conservative opposition to back the plan agreed with international lenders and signs of revolt in his own socialist party, Papandreou said he was confident the deeply unpopular package of spending cuts, tax hikes and privatizations would pass.

"It is a moment of historic importance. If everybody resists, worse things will come, perhaps even bankruptcy," Papandreou told a news conference at the sidelines of a summit of European Union leaders in Brussels.

The meeting saw euro zone governments discuss a new bailout package for Greece, which could include up to 30 billion euros from the private sector to help cut Greece's huge public debt.

President Nicolas Sarkozy said French banks had agreed to participate in a voluntary rollover of Greek debt, Spain's Jose Luis Rodriguez Zapatero said Spanish banks were willing to take part in a scheme to buy Athens more time while Berlin has asked German banks to state their intentions next week.

"We have had many meetings with the banks and insurance companies. There is no difficulty," French President Nicolas Sarkozy told reporters after the meeting.

However, no new money will flow unless the Greek government enacts deep cuts and markets remain skeptical. The euro fell sharply on doubts the government will win the day after a maverick ruling party member said he would vote against.

"It's very ugly; a complete mess," said a trader in London. "There's a rumor the austerity won't pass."

After a difficult series of meetings this week, new Greek Finance Minister Evangelos Venizelos thrashed out an agreement with inspectors from the EU and the International Monetary Fund on Thursday to release the funds Greece needs immediately.

But if the vote next week is lost, international lenders are unlikely to release a 12 billion euros funding tranche, meaning the government will run out of cash within days.

Greece accepted a package of 110 billion euros of EU/IMF loans in May 2010 but now needs a second bailout of a similar size to meet its financial obligations until the end of 2014, when it hopes to return to capital markets for funding.

International lenders want binding commitments that Athens will push through the painful measures judged necessary to get its shattered public finances back in order.

The government won a vote of confidence this week with 155 out of 300 votes in parliament, showing how tight the June 29 vote on its austerity package could be.

In a sign of the uncertainty around the vote, which will be accompanied by a two-day general strike, one deputy from the ruling PASOK party said he will oppose the mix of higher taxes, spending cuts and state selloffs.

"Shops are shutting down every day and we are taking anti-growth measures," party maverick Thomas Robopoulos, a car dealer from Greece's second city, Thessaloniki, and one of the few businessmen in parliament told Reuters. "I will take the floor in parliament and try to convince them to do something."

Daily protests continue in Athens and other cities and an opinion poll on Friday put Greece's conservative opposition 2.1 points ahead of PASOK and showed three quarters of Greeks oppose the raft of tax hikes and spending cuts that will hit them hard.

Greece's partners have expressed growing impatience with what they see as a refusal to face the seriousness of the situation. The attitude of the conservative opposition, which has said it will oppose parts of the package, has particularly enraged European leaders.

"I made it very clear that for the acceptance and for the stability of Greece, it would be highly desirable for the opposition to vote for this package," German Chancellor Angela Merkel said in Brussels.

GETTING BANKS ON BOARD

As well as reform commitments by Greece, private sector involvement in a new rescue is seen by many governments as a vital element to meet objections that European taxpayers were left to foot the bill for saving bank balance sheets.

But it has been complicated by the fact that any scheme must be voluntary, otherwise it risks being classified by credit ratings agencies as a default, or at least a "credit event," which could have serious repercussions for financial markets.

Banking sources told Reuters that European banks and finance officials were discussing a proposal to replace existing Greek debt with a different type of bond to get around ratings agencies' reservations.

The proposal is for a voluntary rollover of debt into securities of a different and not comparable credit composition to avoid agencies moving Greece to default status.

"I don't want to comment on the current state of these talks, I think it's most important for us to have these talks first and then report to you the results," Merkel said. "I don't think it would be wise to give you any numbers. We don't have any hard numbers as of yet.

At the EU summit in Brussels, Papandreou promised to push through radical economic reform after Venizelos clinched agreement with EU and IMF inspectors on extra tax rises and spending cuts to plug a 3.8 billion euro funding gap within an agreed five-year austerity plan worth 28.4 billion euros.

On Thursday, Venizelos announced additional measures including extra spending cuts, lowering the minimum income tax threshold and imposing a special "solidarity levy," measures that will hit ordinary Greeks yet harder.

Employees at Greece's dominant electricity producer PPC, which is slated for privatization next year, were on rolling 48-hour strikes for a fifth day on Friday. The union opposes plans to sell a 17 percent stake in the firm and said the labor action will lead to power cuts.

"Many thought the change of guard at the finance ministry would have helped the weak income groups and those who consistently pay their taxes," said Ethnos, a center-left daily that is normally supportive of the government. "Unfortunately, these hopes were dashed."

(Additional reporting by Emmanuel Jarry, Julien Toyer, Fiona Ortiz, Alex Chambers and Philipp Halstrick, writing by James Mackenziez)

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