Euro zone crisis escalates on Greek debt fears

Chairman Timo Soini of the True Finns celebrates with supporters after hearing the results of first preliminary votes of Finnish parliamentary elections at the party's reception in Helsinki April 17, 2011. Finns went to the polls in parliamentary elections on Sunday.

BERLIN/ATHENS (Reuters) - Fresh fears that Greece will have to restructure its mountain of debt, possibly as early as this summer, sent the euro and some euro zone bond prices tumbling on Monday as the bloc's debt crisis escalated.

German government sources told Reuters in Berlin that they did not believe Greece, which sealed a 110 billion euro ($158 billion) bailout from the EU and IMF a year ago, would make it through the summer without a restructuring.

Market confidence was also hit by a new threat to Portugal's pending bailout from the rise of an anti-euro party in Finnish elections.

The anti-euro True Finns party scored big gains in a Sunday vote and vowed to push for changes to a Portuguese rescue by the EU that is expected to total 80 billion euros when it is finalized by a mid-May deadline.

After a brief lull in the EU debt crisis at the start of 2011, it has blown up again and some analysts are now openly speculating that Greece and possibly other countries could eventually be forced to exit the bloc.

"You may see some countries deciding to leave the euro because they can't deal with the fiscal straitjacket that it imposes on them," Andrew Lynch, a fund manager at Schroders, told Reuters Insider.

A restructuring of Greek debt would be the first by a west European nation in over half a century and represents a challenge for EU policymakers struggling to reconcile the interests of their citizens with the costly steps needed to preserve the integrity of the 17-nation currency area.

Greece, saddled with a debt burden that is expected to swell to 160 percent of gross domestic product by 2013, has denied repeatedly that it plans to restructure. Bank of Greece Governor George Provopoulos warned on Monday it would have "catastrophic consequences."

"To be clear, Greece has money," when considering the public wealth that could be privatized, ECB Executive Board member Lorenzo Bini-Smaghi told Reuters Insider before a New York event sponsored by Chatham House, the home of the Royal Institute of International Affairs.

"You have the alternative of selling assets and accelerating privatization or going in the direction of major financial collapse, which would happen in the case of default or restructuring."

But German newspaper Die Welt quoted an unnamed Greek minister as saying it was only a matter of time before the government took such a step.

And government sources in Berlin told Reuters that some form of debt restructuring now looked unavoidable and suggested Greece move fast, rather than wait until its funding situation gets critical next year.

"Decisive voices within the federal government expect that Greece will not make it through the summer without a restructuring," a high-ranking German coalition source said.

CONTAGION RISK

European shares sank to their lowest close in three weeks on Monday and the euro fell more than two cents to trade briefly below $1.42, its lowest level against the U.S. dollar in nearly two weeks as the euro zone debt crisis rattled market confidence.

U.S. stocks also took a hit after Standard & Poor's cut its credit outlook for the United States to negative in a reminder that the euro zone is not alone in suffering from high debt and deficits.

The cost of insuring Greek debt against default jumped and Spanish 10-year bond yields rose toward record highs near 5.6 percent, while Portuguese yields hit a new peak of 9.4 percent.

European officials have been at pains to stress that Spain can avoid the contagion that has forced Greece, Ireland and Portugal to seek rescues. Its much larger economy could strain the bloc's resources to breaking point if it did succumb to the need for a debt bailout.

Data on Monday showed an accelerated drop in Spanish housing prices in the first quarter and a surge in yields at a government treasury bill auction.

Spain faces a further test of demand for its debt on Wednesday when it aims to raise 2.5 to 3.5 billion euros with two long-maturity issues.

GREEK DEBT BIGGER THAN ARGENTINA BEFORE DEFAULT

In order to return Greece's economy to a sustainable path, most economists agree that it needs to write off roughly half the value of its outstanding debt, hitting private creditors with significant "haircuts" on their holdings.

Greece's debt load of 325 billion euros is nearly double the level most economists see as sustainable and far bigger than that of Argentina when it defaulted in late 2001.

But EU leaders have promised not to make private debt holders pay before 2013.

Doing so in the near-term, when the bloc remains vulnerable, could raise pressure on Portugal and Ireland to restructure their debt also, threatening bank balance sheets in the euro zone.

Winning creditor agreement for a milder form of restructuring, like a voluntary extension of debt maturities, is likely to be difficult.

And even if it does work, it would probably not make enough of a dent in Greece's debt burden to ensure sustainability over the longer-term. Markets may view the "restructuring lite" option as merely the first step in a two-stage restructuring, with the real pain yet to come.

PORTUGAL BAILOUT AT RISK

Meanwhile, in neighboring Portugal, representatives of the European Commission, European Central Bank and International Monetary Fund were meeting government officials on Monday to set the terms for the bloc's third rescue in a year following multi-billion euro deals for Greece and Ireland.

After the election in Finland, however, that bailout could come under threat.

The anti-euro True Finns party which scored big gains in the Sunday vote, vowed to push for changes to the Portuguese rescue.

It may take weeks to find out whether True Finns will become part of a new government in Helsinki and be able to deliver on that threat. The party that won the most votes in Finland is pro-European and seems unlikely to compromise its stance even if it does end up in a coalition with True Finns.

But the result underscored the extent of public anger in northern Europe at the series of aid deals for stricken euro zone countries that mismanaged their economies and finances.

"It is extremely difficult for politicians in Europe to ignore the strong signal from Finland," said Steen Jakobsen, chief economist at Saxo Bank. "Ultimately this could mean a move away from bailouts with no burden sharing by private investors and banks."

Any delay in approving the bailout deal for Portugal beyond May could leave the country scrambling for new sources of funding. It faces an election on June 5 and has warned it will run out of money around the same time.

(Reporting and writing by Noah Barkin; additional reporting by Al Yoon in New York)