Germany sticks to demand for Greek bond swap

BERLIN/ATHENS (Reuters) - European paymaster Germany stuck to its guns on Friday in demanding that private investors contribute to a second bailout for Greece despite a European Central Bank warning against triggering market turmoil.

Finance Minister Wolfgang Schaeuble urged parliament in Berlin to back additional aid for the heavily indebted euro zone country but said private creditor participation in a new package was "unavoidable."

The Bundestag (lower house) approved a non-binding resolution supporting extra emergency loans to Greece that calls for bondholders to share the burden.

To sway skeptical lawmakers in Chancellor Angela Merkel's center-right coalition, fed up with bailouts, Schaeuble warned of disastrous consequences if further aid were not forthcoming and Athens were tipped into a disorderly default.

Like other north European creditors, he insisted that Greece must make further painful reforms, and that banks and insurers which hold Greek debt must share the risk with taxpayers.

"If there are doubts about the ability of Greece to pay back its debt and we must win time with a new package, then the participation of the private sector in the solution is unavoidable," Schaeuble said.

At a Brussels summit on June 23-24, European Union leaders are due to finalize a new rescue package for Greece that officials say will total 120 billion euros until 2014, including 30 billion from privatization receipts and a targeted 30 billion from the private sector.

The risk premiums on peripheral euro zone sovereign bonds rose further on Friday as investors fretted over the lack of consensus just two weeks before the summit.

But European Council President Herman Van Rompuy, who will chair the EU summit, said he was confident there would be an agreement on a new package for Greece by the end of the month, "creating no default or credit event."

Schaeuble told parliament he had proposed to euro zone partners a swap of Greek bonds that would lengthen maturities by seven years while maintaining the existing interest rate.

"This would give Greece the necessary time to carry out reforms and win back confidence," he said.

"It would limit the risks of a negative market reaction, establish fair burden-sharing between taxpayers and the private sector and send a clear signal to all that losses cannot be pushed on to taxpayers alone."

ECB OPPOSED

ECB President Jean-Claude Trichet made clear on Thursday the central bank opposed any scheme for private sector involvement that would cause a "credit event" or be considered by credit ratings agencies as a "selective default."

"We exclude all concepts which would not be purely voluntary, without any elements of compulsion," Trichet told a news conference. "We call for avoiding any credit event and selective default. And of course, default."

The ECB is concerned that tinkering with Greek debt may set off a chain reaction in financial markets that would stretch far beyond Greece and undermine the creditworthiness of other stressed euro zone sovereigns.

The international body that adjudicates on events that could trigger the payout of default insurance has said it would not typically regard a voluntary bond swap or a rollover of maturing debt as a "credit event."

However, all three ratings agencies have said they would be likely to classify even an ostensibly voluntary debt swap as a "selective default," since it was hard to imagine a rational investor would maintain exposure to Greece without coercion.

That could drive the ECB to reject Greek bonds as collateral in its liquidity operations, leaving Greek banks stranded. But many analysts doubt the central bank would take that risk.

ECB TO COMPROMISE?

Clemens Fuest, an academic adviser to the German Finance Ministry, said the ECB had backed down in past stand-offs in the euro zone crisis and was likely to compromise now.

"The language is stark at the moment, but if we look back, the ECB has bought government bonds during this crisis to fight the crisis, so it is already a party in the crisis and it has deviated from the very strict and clear rules for normal situations," Fuest told Reuters Insider TV in an interview.

"These rules are fine for normal situations but in the crisis we have to find something, to find solutions, so I think in the end the ECB will be ready to compromise."

France favors a less sweeping form of private sector involvement in which bondholders are asked to commit voluntarily to roll over their Greek bonds when they mature, sources familiar with government thinking say.

French President Nicolas Sarkozy will hold talks with Merkel on the euro zone crisis next Friday in Berlin in what could be a decisive meeting between Europe's central powers a week before the EU summit.

Schaeuble acknowledged the ECB was opposed to his ideas for private sector involvement in a Greek solution, but said euro zone ministers had agreed to set up a working group to work on a solution that avoided negative market consequences.

The ECB, International Monetary Fund and European Commission would participate in the working group, he said.

In Athens, Greek Prime Minister George Papandreou defended a new austerity package from attacks in parliament, saying it was the only way the EU and IMF would rescue Greece from bankruptcy.

Anxious to pass a mid-term economic plan which imposes years of more austerity in the face of labor strikes, mass street protests and dissidents within his own ruling Socialist party, Papandreou made clear Greece had not choice.

"The medicine is not pleasant and the treatment requires devotion and commitment," he told parliament. "No prime minister of any country wants to go out with a beggar's tray and collect money from other countries ... I certainly don't, but I do it for Greece."

(additional reporting by Lefteris Papadimas in Athens, Erik Kirschbaum and Christiaan Hetzner in Berlin, Kirsten Donovan in London and Daniel Flynn in Paris; writing by Paul Taylor)