Euro zone crisis heads for September crunch

Over the past couple of years, Europe has muddled through a long series of crunch moments in its debt crisis, but this September is shaping up as a "make-or-break" month as policymakers run desperately short of options to save the common currency.

Crisis or no crisis, many European policymakers will take their summer holidays in August. When they return, a number of crucial events, decisions and deadlines will be waiting.

"September will undoubtedly be the crunch time," one senior euro zone policymaker said.

In that month a German court makes a ruling that could neuter the new euro zone rescue fund, the anti-bailout Dutch vote in elections just as Greece tries to renegotiate its financial lifeline, and decisions need to be made on whether taxpayers suffer huge losses on state loans to Athens.

On top of that, the euro zone has to figure out how to help its next wobbling dominoes, Spain and Italy - or what do if one or both were to topple.

"In nearly 20 years of dealing with EU issues, I've never known a state of affairs like we are in now," one euro zone diplomat said this week. "It really is a very, very difficult fix and it's far from certain that we'll be able to find the right way out of it."

Since the crisis erupted in January 2010, the euro zone has had to rescue relative minnows in Greece, Ireland and Portugal as they lost the ability to fund their budget deficits and debt obligations by borrowing commercially at affordable rates.

Now two much larger economies are in the firing line and policymakers must consider ever more radical solutions.

If Spain, the euro zone's fourth biggest economy and the world's 12th, loses affordable market financing the next domino at risk of falling is Italy - the euro zone's third biggest economy and a member of the G7 group of big wealthy nations.

A bailout of Spain would probably be double those of Greece, Ireland and Portugal combined, while Italy's economy is twice as large as Spain's again.

The European Union has already agreed to lend up to 100 billion euros to rescue Spanish banks. One euro zone official said Madrid has now conceded that it might need a full bailout worth 300 billion euros from the EU and IMF if its borrowing costs remain unaffordable.

European officials have spent the past few days issuing a series of statements declaring they will act to halt the crisis.

In the latest, issued on Sunday, Chancellor Angela Merkel and Prime Minister Mario Monti "agreed that Germany and Italy would do everything to protect the euro zone".

The wording was similar to remarks by European Central Bank chief Mario Draghi last week prompted buying in financial markets on the expectation that the bank would take steps to lower the cost of borrowing of Spain and Italy.

Last chance options

Policymakers are working on "last chance" options to bring Greece's debts down and keep it in the euro zone, with the ECB and national central banks looking at also taking significant losses on the value of their bond holdings, officials said.

If governments swallowed the bitter pill by also accepting a cut in the value of their contributions to loans already made to Greece, this would break a taboo and could provoke demands for similar treatment from Ireland or Portugal.

Peter Vanden Houte, chief economist at ING bank, said euro governments might be forced to accept a halving of the value of their Greek debt - known in the business as haircut.

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