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EU raises stakes in crisis with new plan

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Oct. 12, 2011, 3:37 p.m. | World — by Associated Press

European Comission President Jose Manuel Barroso answers questions to reporters during a press conference in The Hague, Netherlands, Tuesday, Oct. 11, 2011.
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BRUSSELS — The European Union's executive is taking its boldest step yet to stem the financial crisis, challenging member states to adopt a broad new plan to avert a second global recession. The proposals to be unveiled by European Commission President Jose-Manuel Barroso on Wednesday afternoon range from strengthening weak banks to lowering Greece's debt burden, and are the sort of comprehensive solution that leaders have long talked about and markets awaited, but which has never come to pass. The Commission hopes states will adopt them at a crucial summit on Oct. 23.

However, the plan will face resistance among the bloc's 27 members, many of which have been wary of putting up more money to shore up struggling governments and banks. Slovakia's rejection this week of eurozone plans to boost a bailout fund was the latest and most dramatic example.

Officials say that the Commission, which is the executive arm of the European Union, sees this as the final opportunity to get a grip on the debt crisis, which has already forced three states into multibillion euro (dollar) bailouts and now threatens to cause bank failures and push the world economy into a second recession.

Ahead of the plan's announcement, banking shares across Europe rallied hard. France's Societe Generale, which is heavily exposed to Greek debt, saw its stock rise 5 percent. Alpha Bank in Athens was up over 16 percent.

In the proposals, which were still being debated by the Commission on Wednesday morning, Barroso is to set out a coordinated plan to increase European banks' capital by lifting the amount of low-risk assets they have to hold to absorb losses on other investments. He will also propose ways to maximize the impact of the European bailout fund so it can help weak governments strengthen their banks and keep the crisis from engulfing Italy and Spain.

The hope is that EU leaders, who are still divided on how to deal with the crisis, will embrace the proposals at their summit on Oct. 23.

"This crisis started with the financial crisis (of 2008). Three years later we are still facing doubts about the capacity of the banks to cope with, for instance, their exposure to sovereign risk," said Amadeu Altafaj Tardio, spokesman for proposal co-author Olli Rehn, a European commissioner.

Until now, the Commission has worked mostly behind the scenes ahead of crucial summits, presenting states with different technical options that were not publicly discussed before the meetings. By unveiling the plans in front of the European Parliament 11 days before the summit, the Commission hopes to pile more pressure on national governments to take on radical options.

This more public approach is risky at a time when many euro-skeptic parties in financially strong states are already campaigning against further aid to the region's stragglers.

Despite the Slovak parliament's "no" vote on expanded powers for the euro bailout fund, stock markets around the world and the euro have rallied over the past week amid expectations of a new EU crisis strategy. If European leaders fail to agree on such a new plan, markets sentiment could quickly turn sour again.

Central to the eurozone's problems is Greece, which has a debt load that would reach around 180 percent of economic output next year if it doesn't try to impose steeper losses on its bondholders.

Several rich states, including the EU's biggest economy, Germany, are already pushing for cuts on bond repayments much steeper than the 21 percent tentatively agreed with banks in July, meaning Greece would essentially have a chunk of its debt forgiven by the banks. But before such a harsh restructuring is implemented, the eurozone needs to strengthen its defenses.

Banks will be expected to increase their capital buffers, forcing them to build up risk-free assets that can absorb losses on bond investments. EU finance ministers last week asked the European Banking Authority to examine what kind of capital buffers would be adequate.

The Commission has warned that many banks are finding it harder to get short-term loans from each other amid fears over their financial health, risking a credit squeeze similar to the one triggered by the collapse of U.S. investment bank Lehman Brothers in 2008, which was a catalyst for a global recession.

The Commission will also propose more creative use of the region's bailout fund, the €440 billion ($600 billion) European Financial Stability Facility. The option that has gained the most traction so far would be to allow the fund to act as an insurer for bond issues from struggling countries like Italy and Spain.

Under such a scheme, the rest of the eurozone, via the fund, would promise to redeem investors for part of any potential losses, making the bonds a much safer investment.
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