German Chancellor Angela Merkel visited Brussels this week to confer with the European Parliament and the Commission on the best way to tackle the sovereign debt crisis and the recapitalisation of Eurozone banks which may be affected from a larger than planned haircut of the Greek debt. At this point, it must be reminded that on 21 July the seventeen Eurozone leaders decided to put together a second package  of €109 billion to support Greece, and also, make the private sector participate in the cost to bail out Athens, through a 21% haircut on the value of Greek bonds they hold, expiring at 2020.

New environment

Now, however, this agreement seems obsolete for two reasons. Firstly, Greece said it cannot cut down the budget deficit of 2011 to the agreed level of 7.5% of GNP agreed, and second, the Greek debt was undervalued in the secondary market from 60 to 45-50 bellow par. Under those new conditions, both the €109 billion package seem a shear waste of EU resources, and at the same time, the 21% haircut on the privately held Greek debt seems now like a gift to banks while offering very little service to the debt stricken country.

In short, the new conditions seem to demand for a greater participation of the private sector, i.e. banks, since their holding of Greek debt is devalued below 50 of its par value. So, one after the other, Eurozone decision makers say that the 21 July agreement does not serve Greece nor the Eurozone and the 21% hair cut should be increased to something between 35% and 50%. If things go this direction, many Eurozone banks – mainly in France, Greece, Germany and elsewhere – will be affected on two accounts; liquidity and capital adequacy.

To this effect, for the first time, Angela Merkel said this past week in Brussels that Germany is ready to recapitalise its banks after the very probable deeper haircut on the Greek debt. Naturally, she said this in Brussels for Paris to hear and to get the message across to the French banks, which are thought to have the largest exposure to Greek debts. At this point, it must be reminded that the European Central Bank has already bought large amounts of Greek, Italian and Spanish debts and the right off of that to the extent of 50% will drive ECB to a position needing also recapitalisation by Eurozone taxpayers, with first among them the Germans.

Germany is ready

In view of the above, it was not by accident that last Wednesday in Brussels, Merkel said,  “the European Union is a priority for her government and her country”. On the same occasion, Merkel also stressed that member states should not shy away from the possibility of changing the current treaties. While in Brussels the Chancellor met with the leaders of the parliament’s political groups, and attended the conference of presidents to discuss issues such as the current economic crisis. Following a meeting with Parliament President Jerzy Buzek, she told reporters that troubled European banks would continue to receive recapitalisation assistance.

Brussels support Berlin

President of the EP Jerzy Buzek praised both the Chancellor, and Germany, for their continued commitment to the EU. “You and your country are a solid rock of European integration. You have not only saved the Lisbon Treaty, but you are also a rock of stability in the storms of the financial crisis,” he said.