The European Union’s Debt Deal: What You Need to Know

Allison Kade
Posted

Halloween is going to be a lot less scary this year than we feared—and not just because we convinced a friend not to dress up as Casey Anthony. At long last, the European Union has reached a deal on Greek debt!

As you can tell, we’re excited. And so is the world: After the announcement on Wednesday night, U.S. stocks soared yesterday morning, Asian markets were stronger almost across the board and European stocks surged.

If you’d like a full rundown of what exactly is going on in Europe and how they got into this debt mess, read this.

What the Deal Looks Like

Here’s the broad outline:

  • Banks and private investors will reduce Greece’s debt by 50%. Banks agreed to do this voluntarily even though it would hurt them (they’d lose 50% of the value of their bonds). But they had little choice: If they didn’t get on board, other European leaders threatened to let Greece default entirely. Which would mean losing 100% of their bonds instead of just 50%.
  • That Greek debt forgiveness comes with 30 billion Euros of “official funding,” meaning that Greece will probably borrow that much from the European Financial Stability Fund (EFSF) to pay it all back.
  • European leaders will increase the power of the EFSF to guard against situations like this in the future. They’ll start by beefing up a rescue fund to 1 trillion Euros, using money from the EFSF and contributions from countries like China.
  • The EFSF will indirectly finance guarantees against default for buyers of Spanish and Italian bonds, since those are two other countries with serious debt woes.
  • To strengthen the continent’s finances, European leaders called for a plan to guarantee medium- and long-term debt funding for banks, which is meant to help with the fact that fewer and fewer investors are buying bank bonds—leaving banks short on funding.
  • In an effort to make banks safer and more stable, large banks will have to maintain better capital ratios, meaning that they’d have to have more actual cash and rely less on government bonds in their portfolios. In all, this would require a “recapitalization” of 106 billion Euros.

This deal was weeks in the making (remember when we first started talking about it?) and came after a longstanding deadlock, but in the end, 17 European leaders finally came together to agree on a solution.

Angela MerkelThere Are Still Some Lingering Questions …

For example, how do European leaders plan to get their rescue fund all the way up to 1 trillion Euros?

 

How are banks supposed to come up with another 106 billion Euros? And will they do it by raising more money or by selling off assets? The latter would almost certainly have a negative impact on the market.

These measures aren’t complete, but they are a good step toward stemming high anxiety around the globe. According to some economists, a real resolution to the debt crisis will take years, since it’ll require highly indebted countries to slowly bring down their debt. All the same, this debt deal is a good signal to the financial markets that European leaders are willing to take any steps necessary to get this problem solved.

German Chancellor Angela Merkel said, “We have to seize this opportunity now or never to correct the architectural flaws made when economic and monetary union was created.”

Image Credit: Flickr/World Economic Forum