What is the eurozone debt deal all about?

It is crunch time for talks on the eurozone debt crisis, and European leaders meeting in Brussels have three main issues to deal with to avert financial disaster.

They need to address the situation in Greece, and how much money the struggling country can afford to pay back (and therefore how much of a hit its lenders have to bear); how serious the situation is in other beleaguered eurozone economies (and what can be done to deal with this); and finally, how to insulate European banks against the crisis.

Channel 4 News has spoken to the leading economist Jonathan Portes, director of the National Institute of Economic and Social Research and former chief economist at the Cabinet Office, to find out what is happening in Brussels today, what it means, and what could happen next.

Q: What is the deal and what is the background?

A: “There are three strands to the deal being discussed.

“The first strand is Greece. The previous deal was for a “voluntary” writedown of Greek debt owned by the private sector by 21 per cent. It was obvious at the time that this was nowhere near enough, and the banks were being allowed to get away with murder.

“I would say that it is quite reasonable to ask the Greek people to accept austerity for their own interest as much as ours. But it is not reasonable to expect them to do that in order to pay back a bunch of irresponsible foreign banks.

“We are now talking about a much more realistic recognition of what the Greeks could be asked and could afford to pay back without crushing them – a writedown of at least 50 per cent and hopefully more.

Read more: Is the eurozone on the brink?

“The second strand is to recognise that some of the Greek debt and possibly other countries’ debts may not be repaid, and that is likely to weaken some banks in the eurozone and even, to some extent, in this country.

“There is a reasonable worry that if the banks are weakened, this could reduce confidence in the financial system, which could lead to another crisis. But even if it didn’t, it would lead to a reduced capacity to lend which would damage the economy.

They are asking the wrong question so they will get the wrong answer. Jonathan Portes, economist

“This is a serious fear and the way to remedy it is to ensure the banks are recapitalised. The figure being talked about is 108bn euros.

“The third strand, and the most important but also the most difficult proposal, is to beef up the bailout fund [the European financial stability fund]. The problem here is that they are asking the wrong question so they will get the wrong answer.

“They are trying to leverage a bailout fund which is backed by national governments. Instead of putting up more money, they are using accounting tricks to pretend we have more money – it’s unlikely to be credible.

“The right answer (as advanced by Martin Wolf in the Financial Times) is that the European Central Bank (ECB) alone has the power to quell the eurozone crisis. Unlike the bailout fund, financed by national governments, the ECB can put up unlimited money. It could say we will stand by governments that are solvent and behave properly to an unlimited amount. The reason why is because if it absolutely has to, it can simply print money – and the fact of it saying this would make it much less likely to happen.”

Read more: The eurozone crisis that keeps repeating itself

Q: What are the stumbling blocks to the deal?

A: “The problem is the big players,” said Mr Portes – not least the problems in Italy, where Silvio Berlusconi’s political power has dwindled so spectacularly that his coalition partners were on Tuesday threatening to bring down the government.

Mr Portes said: “That’s damaging, while the French are constrained by worries over the sovereignty of their banks, the Germans are constrained by understandable domestic political concerns, the ECB worries that all the problems are being dumped on it and governments are being let off the hook.

“That’s understandable, but I feel, wrong, given this crisis. I still think the scale of the crisis means that they should do what Martin Wolf has said [turn to the ECB], but it is not easy.”

Q: What might happen?

A: “Firstly, this is now entirely political. Secondly, it is pretty rare – although not unprecedented – for meetings like this to end in complete deadlock so I think they will probably agree something. But thirdly, the probability of them agreeing something that is credible and convincing and does the job, as I’ve said, is clearly much less.

“The best case scenario is that we all – the eurozone and us – continue to muddle through, continuing – and this is, let’s face it, not great – with relatively weak growth.

“Then you can invent lots of downside scenarios and quickly become very speculative but certainly a failure to agree, and continued instability in the European financial markets and a crisis of confidence in eurozone debt, it’s impossible to know where it would go – it’s too soon to discuss the break up of the euro, that’s too speculative – but it would have a serious impact on the eurozone economy and our economy.”