Image: Athenians riot against austerity
Maro Kouri  /  Polaris
Riots engulf Athens as Greece's ruling Socialists launch talks to form a coalition government with rival conservatives. news services
updated 6/16/2011 6:04:14 PM ET 2011-06-16T22:04:14

Prime Minister George Papandreou, assailed by violent demonstrations and political defections, fought on Thursday to form a Cabinet that would back painful measures to avoid defaulting on the national debt.

In a sign of how difficult his task is, Papandreou postponed announcing a planned Cabinet reshuffle until Friday, after working for hours on Thursday night to win support for an austerity package demanded by international lenders in return for more aid.

"The reshuffle will be announced tomorrow at 9 o'clock (0600 GMT) and the Cabinet will be sworn in at 1 o'clock," government spokesman George Petalotis said.

Papandreou has struggled to garner support for a new package of €28 billion ($39.5 billion) in spending cuts and tax hikes demanded by the European Union and the International Monetary Fund, which last year granted his debt-ridden nation €110 billion ($155 billion) in bailout loans.

But the measures have sparked riots on the streets of Athens and open criticism from his own Socialist lawmakers. Papandreou's desperate efforts to form a coalition government with the opposition conservatives collapsed Wednesday, and the political crisis deepened Thursday when two of Papandreou's lawmakers resigned.

Story: Greek debt tsunami could reach US shores

The party feud heightened worldwide concern that a Greek financial collapse could trigger panic elsewhere in the 17-nation eurozone — a fear that saw borrowing costs in vulnerable EU countries surge and stock markets come under pressure.

"We will prevail and we will hold on. We have as a country in the past successfully faced major crises. As hard at this struggle is, we cannot run away from our fight," Papandreou told party lawmakers. "We will fight and we will win, for Greece, its people and the future of the new generations."

Fearing further chaos, the EU's top financial official, Olli Rehn, indicated in Brussels that Greece will likely get its next financial lifeline in July, despite the EU finance ministers' failure to agree on a new bailout package for the country.

PhotoBlog: Greek protesters tear-gassed, arrested during demonstrations

Rich EU countries like Germany and the Netherlands want private creditors to share a big part of the burden of helping Greece, while the European Central Bank fears those demands could trigger a partial default that would spark panic on financial markets and pummel banks in Greece and across Europe.

Rehn, the EU's monetary affairs commissioner, said eurozone ministers would likely agree Sunday to give Greece the next €12 billion ($17 billion) loan from last year's €110 billion package. However, the aid will only be paid if Papandreou's government, which faces a vote of confidence within days, can get new budget cuts and privatizations through parliament before the end of the month.

The loan would keep Greece afloat until September and give finance ministers and the ECB until their next get-together in July to resolve their differences, Rehn said.

His comments raised hopes that Greece would avoid a quick default, alleviating the selling pressure on the euro, which had earlier fallen below $1.41 for the first time in three weeks.

But fears of a second Greek bailout drove the yield on Greece's two-year bonds above 30 percent for the first time ever Thursday and kept the 10-year equivalent near all-time highs around 18 percent.

Even if a second bailout is granted to Greece, many analysts think the road will still end in default, and some even wonder if Greece will stay in the 17-nation eurozone.

"While an additional bailout package may stave off near-term disaster, a major debt restructuring seems inevitable at some point and Greece's future in the currency union is looking ever more doubtful," said Jonathan Loynes, chief international economist at Capital Economics.

Some economists fear that a Greek default would trigger financial chaos like the Sept. 2008 collapse of the U.S. investment bank Lehman Brothers.

"The risk of a 'Lehman moment' for the eurozone is increasing," says Neil MacKinnon, analyst at VTB Capital.

Nout Wellink, a member of the ECB's rate-setting council, said the situation means that European governments need to be ready to double the size of their bailout fund to €1.5 billion — a prospect sure to irritate German Chancellor Angela Merkel, who faces unrest at home over Germany's role as the leading funder of bailouts.

Image: George Papandreou
Petros Giannakouris  /  AP
Prime Minister George Papandreou

In Athens, Papandreou said he would keep seeking a consensus with the opposition over the financial reforms that creditors have demanded.

"I will serve and continue to serve the effort for broader consensus and we hope that this effort ultimately is successful," he said.

He admitted his government had displayed "mistakes and weaknesses," but promised a new, stronger Cabinet in a reshuffle.

His strong words failed to reassure, and prominent Socialist lawmaker Vasso Papandreou was stinging in her criticism.

"The measures we are implementing are only cuts in salaries and pensions," she said during the emergency meeting. "We voted for other measures but we have not implemented them."

The lawmaker — who is not related to the prime minister — said Greece was in a worse condition now than when it first passed austerity measures last year.

"We have managed to mobilize nearly all of Greece's society against us," she noted.

The Associated Press and Reuters contributed to this story.

Video: U.S. fears fallout from Greece debt crisis

  1. Closed captioning of: U.S. fears fallout from Greece debt crisis

    >>> we told you here last night about the rioting and political turmoil in greece as that nation faces down a possible default on its debt. tonight the situation still hanging by a thread officially. and the outcome could easily cause a serious blow back here in the u.s. cnbc's michelle cabrera is with us tonight from athens. michelle, we're looking at the scene over your shoulder. such a beautiful picture. i understand the situation on the streets was better today, but give us an update of the situation behind the scenes and remind everybody how this could be felt officially here in the u.s.?

    >> reporter: behind the scenes it's still a very desperate situation. they are worried economists and government officials are worried that if greece fails to pay its debts it may havave a similar ripple effect just like when lehman brothers collapsed here in the united states . we felt the deep recession afterwards because the economy is so connected. financial experts here aren't convinced that will happen but they don't want to find out. what's hatching right now the greek government right now is working desperately to try and pass a budget with deep budget cuts. but those cuts are so painful, that has led to rioting in the street. they need to do those cuts in other words to qualify for a loan from the imf, they need billions from the imf just to pay their bills through the summer. that government's new budget means deep, deep layoffs. more than 100,000 people could lose their jobs in the government. they're going to have to pay higher taxes as well. and everybody in the country will be facing higher taxes.

    >> we're glad you're there covering the story.

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