European finance ministers are working to resolve a quandary over how to talk banks into “voluntarily” contributing to a second Greece bailout and avoiding a destructive debt default. This attempt to rescue Greece’s finances hinges on how far banks, pension funds and insurers will accept new terms on old debts prior to repayment by Athens.  Greece has accumulated 350 billion euros ($500 billion) of debt, more than its entire economy produces in 18 months.  The European Central Bank (ECB) is concerned that requiring private investors to help could see the credit ratings agencies deem Athens to be in default, an enormous risk for the entire eurozone.

European finance chiefs are hammering out a Greek rescue to prevent sovereign default after the country was given the world’s lowest credit rating by Standard & Poor’s.  According to Dutch Finance Minister Jan Kees de Jager, “We need to make it as voluntary as possible to prevent triggering scenarios that cost more and make financial markets lose all confidence in the eurozone.”

German Finance Minister Wolfgang Schaeuble is firm in his belief that taxpayers in the eurozone’s biggest economy will be willing to lend Greece more money — but only if banks and private creditors take their own hits.  “The German government is ready to participate in supplementary measures,” Schaeuble said, but, “of course, a role for the private sector is an element.  We are in discussions.”  Austrian Finance Minister Maria Fekter echoed this hardline stance, noting that “we can’t leave the profits in the hands of the banks and the losses in the hands of taxpayers.”  The chairman of the 17-nation currency Eurogroup, Luxembourg Prime Minister Jean-Claude Juncker, said the finance ministers had come together “to examine different options…all the options.”  Additionally, Germany is supporting a bond swap that would push out the maturities on Greece’s debt by seven years, giving it more time to rebalance its economy and sell state assets.

According to Finnish Finance Minister Jyrki Katainen, “Most of the countries have indicated that some form of private sector involvement is crucial,  I want to underline that we have to avoid, whatever it takes, the next financial crisis.  The balance is very difficult.”  A new aid package for Greece is expected to be finalized at an upcoming European Union summit.

A majority of German banks say they can withstand Greek debt restructuring, according to Christoph Schmidt, an economic adviser to Chancellor Angela Merkel.  A “soft restructuring” would have little effect on Greece’s debt burden and eventually creditors — including the European Central Bank — will have to write off part of their Greek sovereign debt, Schmidt said.

A more pessimistic viewpoint was expressed by European Central Bank Governing Council member Christian Noyer,  who said any attempt by eurozone governments to fine-tune Greek debt that results in a default means financing the nation’s entire economy.  “Our position is extremely simple: if there is a solution that avoids a risk of default, it seems suitable,” Noyer said.  “If you can’t find it, it’s better to avoid touching the debt.  If, despite everything, you try to reduce the debt and you provoke a risk of default, you’ll have to finance the entire Greek economy.  We’ve gone as far as possible in our interpretation of the quality of debt.  If we have debt in default, it will be impossible to consider that we have quality debt.  Therefore it will become impossible to accept this debt as collateral.”  Believing that restructuring or rescheduling can lead to a relaxation of budget plans is a “dangerous illusion,” he said.  “Such operations do not in themselves provide any new financing.  They always lead, at least initially, to a further drop in confidence and lower capital inflows, which increases the adjustment effort needed.”  Noyer also rejected suggestions that the ECB’s stance was related to concerns about the ability of European banks to absorb losses on Greek debt, or even about the ECB taking losses on its own Greek holdings.

The position “has nothing to do with the situation of French or German or European banks, and nothing to do with the fact that the euro system holds Greek debt,” he said.  “That’s rubbish.  Our one and only concern is the financing of the Greek economy.  We must absolutely avoid anything that could result in a default,” Noyer said.  “It would be an extraordinarily serious risk for the financing of the Greek economy and would be one for a certain number of euro-zone regions after that.”

Greece now has the dubious honor of being the lowest-rated sovereign in the world, below Ecuador, Jamaica, Pakistan and Grenada. According to Standard & Poor’s, “In our view, Greece is increasingly likely to restructure its debt in a manner that, under the conditions of any package of additional funding provided by Greece’s official creditors, would result in one or more defaults under our criteria.”