Talks between Greece and its creditor banks to slash the country's towering debt pile broke down on Friday, with the Greeks warning of catastrophic results if a deal to swap bonds is not reached soon.
The sides remain divided over the interest rate Greece will end up paying, which determines how much of a hit banks take.
Athens needs an agreement, seeing creditors voluntarily giving up a lot of their promised returns, to reduce its debt to more sustainable levels and convince the European Union and International Monetary Fund to keep lending it cash.
Both sides appeared to be digging in their heels, in what analysts said looked like a high stakes poker game in a final attempt to convince private bond holders to take some losses to avoid a disorderly default.
It would come via a swap between old bonds teetering on the brink of default and new ones for which banks would take a big hit. Without a deal, banks could lose even more and Greece would be threatened with default and possibly euro zone ejection.
Discussions with Greece and the official sector are paused for reflection, said the Institute of International Finance (IIF), which leads talks for private bond holders.
Unfortunately, despite the efforts of Greece's leadership, the proposal put forward ... has not produced a constructive consolidated response by all parties.
Greek negotiators earlier warned that failure to reach a deal would be disastrous for Europe.
Yesterday we were cautious and confident. Today we are less optimistic, said a source close to the Greek task force team in charge of negotiations.
It is important to remind all parties that the consequences of failure would be catastrophic for Greece and the Greek people, Europe and Europeans, the source said.
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The stumbling block in the negotiations was the low coupon, or interest payment, offered on the new bonds, one source familiar with the matter and one banking source said.
The main problem was the (European Union and International Monetary Fund's) insistence on a coupon lower than 4 percent on the new bonds, the banking source said.
It could mean an accounting loss of more than 70 percent for banks on their books, far more than the actual 50 percent cut in the original value of the old bonds laid down in the original deal.
Under the terms of the October plan, bondholders would take a 50 percent hit on the notional value of the old bonds. But the actual losses on their books depend on coupon and maturity, and could be far higher.
When you're dealing with a sovereign, you don't have a huge amount of tricks up your sleeve, because if they choose not to pay you there's not an awful lot you can do, said Gary Jenkins, director of Swordfish Research.
The IIF's Charles Dallara held meetings in Athens on Thursday and Friday and Finance Minister Evangelos Venizelos said talks would most likely resume next Wednesday.
There is a meeting next week and we'll make every effort to succeed, the source close to the Greek side said.
The IIF said there was a tentative plan to meet on Wednesday, but that it depended on events in the next few days.
Timing is pressing, as Greece needs a deal to stay afloat when a 14.5 billion euro major bond comes due March 20, and the bond swap paperwork alone will take at least six weeks.
EU, IMF and ECB inspectors, who arrive in Athens on Tuesday for talks on a new, 130-billion-euro rescue plan, also want to see a deal on the debt swap before they agree on the bailout.
Any agreement with private bondholders on debt reduction should be in line with the terms decided by euro zone leaders on October 26, the EU Commission said on Friday.
A lot of the (old) bonds have traded and are in the hands of the hedge funds. Do you think the governments are going to (pay out) to hedge funds? No way. So people like us, unless we are forced, we don't have an incentive to accept, said a source at a hedge fund, which owns Greek bonds.
Under the terms agreed in October, Greek privately held debt would be reduced by half, so that, together with structural reforms, the overall debt to GDP ratio of Greece would fall to a sustainable 120 pct in 2020 from 160 percent now.
A government spokesman said earlier that Greece had not decided yet on whether it will submit a law to force creditors into the bond swap, denying a Greek media report that it would do so by Monday.
Three senior euro zone sources told Reuters on Thursday that Athens was mulling such a bill, which would make a debt restructuring binding for all investors once a certain percentage agreed.
Without using so called collective action clauses, the participation rate in any debt swap deal could be smaller than needed because many hedge funds would profit more if Greece defaulted because they would get paid in full from insurance.
(Additional reporting by George Georgiopoulos and Lefteris Papadimas in Athens, Douwe Miedema, Steve Slater and Tommy Wilkes in London. Editing by Jeremy Gaunt.)