BRUSSELS — Eurozone leaders on Thursday agreed to a sweeping deal that will grant Greece a massive new bailout — but likely make it the first euro country to default — and radically reshape the currency union's rescue fund, allowing it to act pre-emptively when crises build up.
The deal resolves a political deadlock between Europe's top economic authorities over how to save Greece that had investors worried the debt crisis would spin out of control. Faced with the danger of big economies like Italy becoming unstable, the officials sought to outdo expectations at an emergency meeting in Brussels.
The eurozone countries and the International Monetary Fund will give Greece a second bailout worth €109 billion ($155 billion), on top of the €110 billion granted a year ago.
Banks and other private investors will contribute some €50 billion ($71 billion) to the rescue package until 2014 by either rolling over Greek bonds that they hold, swapping them for new ones with lower interest rates or selling the bonds back to Greece at a low price.
"For the first time since the beginning of this crisis, we can say that the politics and the markets are coming together," said European Commission President Jose Manuel Barroso.
Initial reaction from markets and analysts to Thursday's deal was cautiously positive. The euro, which had rallied sharply on expectation of the deal, rose further to gain 1.2 percent against the dollar.
The "summit conclusions surprise by their size and range," Marie Diron, senior economic adviser to the Ernst & Young, said in a note. "The measures imply significant private sector involvement and very large further support from the EU. All politically acceptable measures are being used."
The deal on involving private creditors is widely expected to be considered a "selective default" by the ratings agencies, making Greece the first euro country to ever be in default — if likely only for a short period of time.
Because of that, the eurozone will back up any new Greek bonds issued to the banks with guarantees. Those guarantees are necessary because Greek banks use Greek government debt as collateral for emergency support from the European Central Bank. Those bonds would no longer work as collateral if hit with a default rating, meaning Greek banks would lose the ECB support and quickly collapse.
In the case of bond rollovers or swaps, the new Greek bonds issued to the banks would have long maturities of up to 30 years and low interest rates, according to the Institute of International Finance, the group representing the private sector creditors. French President Nicolas Sarkozy estimated the rates would average 4.5 percent.
That will give Greece more time to get its struggling economy back in shape and cut some 21 percent of its future debt burden.
Leaders agreed to provide the new eurozone rescue loans to Greece at a 3.5 percent interest rate and with maturities of between 15 and 30 years. They will have an additional grace period of 10 years.
"I think this is extremely important to ensure the debt sustainability of Greece," Barroso said.
In addition to the new aid for Greece, the leaders also overhauled their bailout fund, giving it the power to intervene in countries before they are in full-blown crisis mode.
The changes to the fund are a big turnaround, especially for Germany, which had blocked any such move earlier this year. They show how worried the eurozone is that its debt crisis could spill over from small countries like Greece, Ireland and Portugal to big ones like Spain or Italy. Bailouts for those countries would likely overwhelm the eurozones financial capacity.
To avoid ever being in that position, the EFSF will be able to provide a "precautionary program," such as short-term credit lines, for struggling countries. Such credit lines could be very helpful for Italy and Spain if they ever experience a funding squeeze, showing investors that support is available if things get tight.
They could also make it easier for Ireland and Portugal to start raising money again on financial markets once their own rescue programs run out.
The EFSF will also be able to recapitalize banks in countries that haven't been bailed out, supporting them during a banking crisis without forcing them into a full program that usually requires massive cuts and economic reforms. That may make it easier for certain countries to request help before market panic has reached its peak.
On top of that, the eurozone can in certain circumstances use the EFSF to buy bonds on the secondary market, taking pressure off countries experiencing an investor sell-off. That was a role that the ECB had reluctantly fulfilled until a few months ago, when it abandoned its bond buying program amid growing frustration with leaders' slow efforts to contain the crisis.
Leaders said Portugal and Ireland will also get lower interest rates on their bailout loans, but stressed that there won't be any private sector involvement in their support programs.
"Private sector involvement will be limited to Greece, and Greece only," EU President Herman Van Rompuy said.Comment on this story
Greek Prime Minister George Papandreou greeted Thursday's deal. "The European Union has taken significant decisions for Greece and for the eurozone," he told reporters. "Today's decisions safeguard the viability of our national debt."
However, some analyst questioned whether the agreement was enough to make Greece's massive debts, some €350 billion or 160 percent of economic output, truly sustainable in the long-run.
"If successful, the program will bring a significant reduction of Greece's debt stock although, on its own, it is unlikely to be enough to bring Greek debt back to sustainable levels," Ernst & Young's Diron said.
Don Melvin, David McHugh, and Sylvie Corbet in Brussels and Derek Gatopoulos in Athens contributed to this article.