European leaders said they secured a deal to reduce Greece's debt after they labored overnight and into Thursday morning to find agreement on what they had billed as a blockbuster package to stem the Continent's debt crisis.
French President Nicolas Sarkozy said after the marathon negotiating session that the leaders had reached agreement with private banks on a "voluntary" 50% reduction of Greece's debt in the hands of private investors.
He also said they had agreed to expand the firepower of the euro zone's bailout vehicle, known as the European Financial Stability Facility, by four- or five-fold—suggesting it could provide guarantees for around €1 trillion, or about $1.4 trillion, of bonds issued by countries such as Spain and Italy.
Mr. Sarkozy expressed satisfaction that the Greek debt agreement wouldn't be forced on holders of Greek bonds. "France wanted to avoid the drama of a Greek default, when you remember the consequences of the failure of Lehman Brothers, and it's done," he said.
German Chancellor Angela Merkel said she was "very satisfied" with the outcome.
The leaders also agreed on a plan that would boost the capital buffers of the stragglers among the Continent's 70 biggest banks by €106 billion—though they didn't say where the money would come from.
After the summit ended, at around 4 a.m. in Brussels, the euro rose strongly against the dollar in morning trading in Asia. Other assets correlated to risk-taking, such as the Australian dollar, copper and oil also rallied. Stocks rose modestly across Asia.
European markets also rallied strongly Thursday, with banking shares leading the gains as investors welcomed the leaders' agreement.
A statement issued after the summit said leaders had agreed on "a comprehensive set of additional measures reflecting our strong determination to do whatever is required to overcome the present difficulties and take the necessary steps for the completion of our economic and monetary union."
As the leaders went into the meeting, deep divisions remained between euro-zone governments and private banks over how much to cut the government debt of Greece, the country at the heart of the crisis.
Such summits rarely end without ostensible agreement among the leaders on the way forward. But many officials had warned beforehand that it would take weeks to negotiate the details of any agreement.
After a day marked by a brawl among Italian lawmakers debating cutbacks in the country's pension system, Italian Prime Minister Silvio Berlusconi took time out from the Brussels summit to call into a popular Italian television show shortly after midnight, criticizing the European Central Bank and dismissing reports he plans to call for early elections.
Governments, led by Germany, had begun the day seeking a real cut in the value of Greek government bonds held by private investors of as much as 60%. The banks, led in negotiations by Charles Dallara of the Institute of International Finance, a Washington-based international bank lobby group, offered a new proposal Tuesday night that officials said had fallen far short of that.
Officials said Ms. Merkel, Mr. Sarkozy and International Monetary Fund Managing Director Christine Lagarde met with Mr. Dallara in the middle of their summit. According to a person familiar with the matter, Mr. Sarkozy warned him that in the absence of an arrangement, private creditors would face a Greek default and 100% losses on their investments.
Mr. Dallara had warned that too radical a deal couldn't be styled as voluntary and would damage Greece and trigger contagion effects around the rest of the euro zone. After the accord was announced, Mr. Dallara issued a statement saying, "The IIF agrees to work with Greece, euro-area authorities and the IMF to develop a concrete voluntary agreement on the firm basis of a nominal discount of 50% on notional Greek debt held by private investors." The deal would be supported by €30 billion of "official funding," he said.
This suggests Greece would borrow an extra €30 billion—on top of the €100 billion in bailout funds it is already getting—from the EFSF to provide guarantees for bondholders who accept the deal.
Mr. Dallara said Thursday that private-sector participation in the deal on a write-down of Greek debt is likely to be "very high." But he said the IIF had made no commitment about the likely level of participation.
Cutting Greece's debt has been complicated by the fact that private creditors hold only about €210 billion of Greece's €350 billion government debt. This makes it harder to reduce Greece's debt substantially, given that official creditors such as the IMF refuse to accept losses. The deal envisages Greece's debt falling to 120% of gross domestic product by 2020.
The leaders, in their plan to boost the firepower of the EFSF to stop further contagion, agreed on two ways of doing this, which would run side-by-side.
Under one method, the EFSF would indirectly finance guarantees covering the initial losses that buyers of Spanish and Italian bonds would suffer in the event of default.
The other is to set up a fund seeded with EFSF money as well as with contributions from cash-rich nations such as China. The head of the EFSF, Klaus Regling, is due in China Friday to discuss how Beijing might contribute to the fund's finance. In a parallel effort, Mr. Sarkozy plans to call China's President Hu Jintao Thursday to discuss the matter, a French government official said Wednesday.
The euro got a boost earlier Wednesday when lawmakers in Germany, Europe's largest economy, backed a resolution approving the proposals for boosting the fund. Germany's Bundestag, or lower house of parliament, passed the resolution without the chancellor's ruling coalition needing to borrow votes from opposition parties. Ms. Merkel told the parliament that Europe must correct mistakes made at the euro's creation.
"We have to seize this opportunity now or never to correct the architectural flaws made when economic and monetary union was created," she said.
Details also emerged over policymakers' plans for strengthening the continent's banks.
The most important new element was a call by European leaders for a plan to provide guarantees on banks' medium- and long-term debt funding. While details aren't clear, the provision is aimed at helping alleviate a drought in the market for bank bonds threatening to leave some banks short on funding next year.
Experts said such a program could prove more important than the higher-profile efforts to coax banks to beef up capital cushions.
The other component of Europe's bank-strengthening plan calls for large banks to maintain so-called core Tier 1 capital ratios of 9%, after adjusting the values of their government bond portfolios to reflect market prices.
Banks will have until June 30, 2012, to come up with any additional necessary capital.
Late Wednesday, the European Banking Authority said leading banks in 13 countries will need to come up with an additional €106.4 billion in so-called core Tier 1 capital by that date. The EBA said it based its evaluation on a sample of 70 banks across the continent.
Banks in Greece, Spain and Italy face the biggest capital holes, and together account for about two-thirds of the overall amount that needs to be raised. The French, Portuguese and German banking sectors each face capital deficits of €5 billion to €9 billion. The EBA deemed banks in the U.K. and Ireland, among others, as having enough capital.
Italy's economy continues to be a concern. In a letter sent to European Union leaders Wednesday, Mr. Berlusconi promised partial reform of the Italian pension system, state-asset sales targeting revenue of €5 billion a year and a loosening of labor laws to make layoffs easier.
In the letter Mr. Berlusconi reiterated a key pledge to balance the country's budget in 2013, and acknowledged that, despite having approved a €60-billion austerity package this summer, the government still has to face a heavy debt burden as well as stagnant growth.
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