Can a 'Big Bang' Plan Save the Euro?

It's easy to see the appeal of the rumors swirling around Europe of a bold plan to the keep the euro zone's single currency together. For almost two years, the 17 euro-zone countries have done little to convince the markets that they're ready and able to do what it takes. The result is that Greece now seems poised to default and even quit the euro, and there is a mounting sense of panic in Europe's corridors of power about the collapse of their signature project. That underscores the allure of this week's chatter that the euro zone is preparing a "big bang" scheme that would write down Greece's debt by 50%, recapitalize European banks and boost the European Union's bailout fund to up to €2 trillion ($2.7 trillion).

The risks of inaction are immense: the euro zone needs to act quickly and vigorously to stanch the bleeding Greek economy and limit contagion to other ailing countries. So far, E.U. leaders have agreed on two bailout packages for Greece and others for Portugal and Ireland. And they've contributed billions of euros in aid to ailing economies while pushing through chilling austerity packages. But markets remain nervous about euro-zone debt levels. They now assume that a Greek default is inevitable and have turned their focus to Italy and Spain, economies that are too big to bail out under the euro zone's current rescue arrangements. As the European Central Bank's Jean-Claude Trichet said over the past weekend, the current situation is more precarious than the defining moment in 2008, when Lehman Brothers collapsed. "We are the epicenter of this global crisis," he warned.

At the same time, Washington is piling pressure on European leaders to hammer out a solution to the crisis before it drags the rest of the world down. On Sept. 27, President Obama said Europe is "scaring the world" with its inaction. And U.S. Treasury Secretary Timothy Geithner said the threats of cascading default, bank runs and catastrophic risk had to be taken off the table. "Sovereign and banking stresses in Europe are the most serious risk now confronting the world economy," he said. "Decisions cannot wait until the crisis gets more severe."

The emerging euro-zone rescue plan has three strands. First, leaders would raise its bailout fund, known as the European Financial Stability Facility (EFSF), from €440 billion ($595 billion) to about €2 trillion ($2.7 trillion). It is still unclear how this would be done, but Geithner suggested the EFSF could be leveraged by acting like a bank and drawing on funds from the European Central Bank (ECB). Critically, this would give it funds to buy government debt from countries that might be frozen out of the financial markets, in particular core euro-zone members Spain and Italy.

Second, Greece would be able to write off half its debt, currently estimated at 160% of GDP and rising. While the euro zone has already secured an agreement for creditors to write off about 20% of what they are owed, the latest suggestion is for a managed default that would shave off at least 50% of the debt. Finally, the plan would pump money into any undercapitalized European banks that run into trouble because of losses on government debt.

Euro-zone policymakers are coalescing around a multifaceted approach that would prioritize a firewall around Italy and Spain. But Sony Kapoor, managing director of Re-Define, a Brussels-based economic think tank, says there is still a long way to go. "Any such deal will have to first reduce the borrowing costs for Spain and Italy, then strengthen capital and liquidity buffers for European banks, and only then decide once and for all how to tackle Greece," he says. In order to tighten compliance and ensure no repeat of the crisis, he predicts, new rules will be set for economic governance: "Any urgent financial-aid measures will no doubt be accompanied by ever stricter rules for the recipients of aid to comply with."

Ostensibly this covers all the bases, and markets around the world reacted positively Monday, Sept. 26, to the rumors. But while these measures promise the emphatic policy response that has been lacking so far, at question is whether the scheme can get through the E.U.'s many institutional and constitutional hoops at a time when solidarity among European nations is at a postwar low.

Policymakers will be watching closely as a swath of European parliaments vote over the next few days on whether to accept the deal forged at a July summit to enhance the €440 billion EFSF. There's no guarantee for support. Many northern E.U. members — including Germany, Finland, the Netherlands and Austria — are showing increasing hostility toward the Greeks, whom they see as wayward and spendthrift. In Germany, polls show that 75% of German voters are against the move, and Chancellor Angela Merkel is expected to rely on the opposition Social Democrats and Greens to secure the parliamentary vote.

The animosity is at least as strong in Greece, where a recent poll showed that 92% of Greeks thought austerity measures were unfair and 72% believed they would fail. With unemployment at 16% and the Greek press filled with stories of foreclosures, bankruptcies and rising homelessness and emigration, it is becoming increasingly hard for Greek Prime Minister George Papandreou to push for more cuts and sell-offs, despite pressure from the E.U., the IMF and markets.

With anger rising across the E.U., it's difficult to broker any plan, no matter how brilliant and ambitious. So even if the rumors of a big bang prove to be true, it will still be a while before the euro zone can hope to see the other side of this crisis.

With reporting by Joanna Kakissis / Athens