ECB May Compromise on Greek Default, Nowotny Indicates

By Jana Randow and Simone Meier
July 19 (Bloomberg) -- The European Central Bank may be willing to accept Greek bonds as collateral in the event of a short-term selective default, Governing Council member Ewald Nowotny suggested today.
“There is a full range of options and definitions, from a clear-cut default, selective default, credit event and so on,”
Nowotny, who heads Austria’s central bank, told CNBC in an interview. “This has to be studied in a very serious way. There are some proposals that deal with a very short-lived selective default situation that will not have major negative consequences.”
It’s difficult to say whether Nowotny is expressing a view that has broader support on the ECB council, said Nick Kounis, head of macroeconomic research at ABN Amro Bank NV in Amsterdam.
“Nowotny is well known as someone who talks a lot,”
Kounis said. “He might be revealing that there’s a little bit more flexibility than what was perhaps assumed. On the other hand, we have to be a bit careful with Nowotny. I’d be cautious.”
The euro rose and yields on Spanish and Italian 10-year bonds retreated from euro-era highs today as stock markets rallied.

Leaders’ Summit

European Union leaders are meeting on July 21 to hammer out a solution to the Greek debt crisis, which has already spread to Ireland and Portugal and is threatening to infect Italy.
While Germany wants private investors to participate in a second bailout package for Greece, ECB President Jean-Claude Trichet says the central bank won’t accept Greek government bonds as collateral for loans in the event of a default or “credit event.”
By contrast, Nowotny said it’s up to the Frankfurt-based central bank to decide what collateral it accepts and it “should not be totally dependent on rating agencies.”
“It is our own responsibility, our own decision,” he told CNBC. “We have proved this in the case of Ireland, Greece and Portugal, with regard to what kind of collateral we accept. So there is a certain case for independence. But of course, not with regard to rating agencies but with regard to our own statutes, there are limitations.”

Bond Yields

Yields on Spanish and Italian 10-year and Greek two-year bonds hit euro-era records yesterday. Spanish 10-year yields fell 15 basis points to 6.17 percent as of 10:09 a.m. in London, narrowing the spread over German bunds to 346 basis points.
Greek two-year yields surged 113 basis points to 35.5 percent while Italy’s 10-year bond yield dropped 23 basis points to 5.74 percent.
EU President Herman van Rompuy asked leaders last week to meet in Brussels to discuss “the financial stability of the euro area as a whole and the future financing of the Greek program.” Yesterday, stocks declined around the world, the euro fell and the cost of insuring European sovereign debt rose to records amid concern the euro region isn’t any closer to solving the crisis a year after Greece’s initial rescue.
A summit was originally mulled for last week before being postponed amid German fears it would backfire without a pact on private-sector involvement. Germany’s government says no extra aid is possible without bondholders staying exposed to Greek debt.

‘Grave Consequences’

“I don’t expect European leaders to reach a decision this week,” said David Kohl, deputy chief economist at Julius Baer Group in Frankfurt. “They’ll continue to fight over whether to include bondholders or not. Still, a Greek debt restructuring wouldn’t be a solution to the problem.”
The euro-region recovery is losing momentum as leaders struggle to contain the debt crisis. In Germany, Europe’s largest economy, investor confidence dropped to the lowest in 2
1/2 years in July, the ZEW Center for European Economic Research in Mannheim said today. European economic confidence dropped in June and manufacturing growth slowed.
Nowotny said a full Greek default must be avoided. “That would have very grave consequences, especially with regard to the ECB and the ability of the ECB to accept Greek collateral,”
he said.

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