Hopes receded for a smooth, "voluntary" restructuring of Greece's sovereign debt yesterday when a leading credit-ratings agency said that such a move would still constitute "selective default".
The cost of insuring Greek and other peripheral eurozone economies' bonds soared again, with the premium asked for insurance against a Greek default hitting 19 per cent of the principal.
It is a further knockback to hopes that private-sector bondholders will be able to ease the cost of a second eurozone/International Monetary Fund bailout, estimated to be about €120 billion ($210 billion) - following the €110 billion package last year.
Standard & Poor's said two proposals advanced by an association of French banks "would likely amount to a default" under its criteria because both offered "less value than the promise of the original securities".
If the other agencies, Moody's and Fitch, follow suit, it would make it much tougher to achieve a deal that involves any cost to the private sector - even if the commercial banks want to volunteer to pay a portion of the cost of a rescue. That, in turn, would inflame public opinion in nations that will have to foot the bill.
The embryonic plan, proposed by a consortium of French banks, some heavily exposed to Greece, and supported by German institutions, would be for banks and other private sector investors to accept a combination of longer maturities or lower coupon payments when their Greek bonds became due for repayment.
New bonds of up to 30 years would be swapped for the old securities, and part of the proceeds used by the Greek Government to invest in other, AAA- rated securities, so improving the current junk-status rating awarded to the Greek debt.
Although in the case of the German banks the sacrifice is comparatively small - only €2 billion - it is politically vital for the German Government to demonstrate that the pain has not being borne entirely by its taxpayers.
Similar political obstacles to a new deal exist in Finland and the Netherlands. S&P said in its report: "The downgrade reflected our view of the rising risk that an enhanced official financing package addressing the Greek Government's 2011-14 financing needs could require private-sector debt restructuring in a form that we would view as an effective default."
It added: "In recent weeks, a number of proposals relating to this topic have surfaced, and the particulars in some cases are evidently still in flux. In brief, it is our view that the options would likely amount to a default under our criteria."
A concession offered at the end of last week, whereby EU government bondholders would rank alongside private sector ones, was not enough to change S&P's mind. The latest developments will inevitably set back the chances of agreement being reached by the time European finance ministers meet again, on Monday.
Amadeu Altafaj Tardio, a spokesman for the EU's monetary affairs commissioner, said work on private-sector involvement was ongoing.
A German Finance Ministry spokesman, Martin Kotthaus, added: "We have to look carefully to see what model we can find to have as few side effects as possible."