EU Battles to Save Euro as Merkel Eyes ‘Step by Step’ Solution to Crisis

By James G. Neuger and Stephanie Bodoni - Dec 9, 2011 1:54 AM GMT+0700

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Dec. 8 (Bloomberg) -- David Trone, managing director at JMP Securities, talks about the the possibility of a breakup of the euro zone. Trone, speaking with Tom Keene on Bloomberg Television's "Surveillance Midday," also discusses former MF Global Holdings Ltd. Chief Executive Officer Jon Corzine's testimony before the House Agriculture Committee today and the outlook for U.S. financial stocks. (Source: Bloomberg)

European leaders battled over the fate of the euro in last-ditch efforts to stem two years of turmoil in financial markets and put the debt-addled continent on a sounder economic footing.

Plans to funnel central bank loans through the International Monetary Fund started to fall into place as French President Nicolas Sarkozy warned “there’ll be no second chance” in the absence of a credible crisis-containment strategy from a summit that began today in Brussels.

Chancellor Angela Merkel of Germany, Europe’s dominant economy, damped expectations, saying the euro’s credibility has suffered and calling the 15th summit in 23 months part of a “step-by-step” solution to the crisis that has cast doubt on the currency’s survival.

European leaders began open-ended talks over dinner at 7:30 p.m., with no press briefing scheduled. They are navigating a labyrinth of political, legal and economic constraints amid unrelenting pressure from financial markets in a bid to craft a fifth “comprehensive” package to stamp out the crisis that began with the Greek government discovering an unexpected budget hole in October 2009.

Spanish and Italian bonds tumbled and the Stoxx Europe 600 Index lost 1.5 percent, reversing a 1 percent advance, as some investors reined in expectations about the summit’s outcome.

Whether the meeting wraps up on schedule tomorrow or runs into the weekend, the leaders are likely to leave Brussels with much business unfinished. Planned amendments to European treaties won’t be penned until March and may take several more months to enshrine in law.

‘Kind of Surprised’

In addition, the independent European Central Bank signaled today that a Brussels deal to tighten budget-deficit rules for the 17 euro governments wouldn’t prompt it to rush to the rescue of Spain or Italy, the two countries now seen as most vulnerable.

ECB President Mario Draghi said he was “kind of surprised” by a view that took hold in markets last week that the central bank would rapidly supplement its 207 billion-euro bond-buying operations in response to a summit announcement of steps toward a closer fiscal union. Draghi is taking part in the summit.

“The ball is still in the politicians’ court, increasing pressure on EU leaders to come up with longer-term solutions for the debt crisis,” said Mohit Kumar, head of European interest- rate strategy at Deutsche Bank AG in London. “This won’t bode well for periphery bonds.”

ECB War Chest

Italian 10-year bonds slid the most in almost a month today, pushing up yields by 44 basis points to 6.43 percent. Bonds of other high-yielding countries also fell as investors sought the relative safety of German debt. The yield on 10-year bunds declined 9 basis points to 2.01 percent. The euro was down 0.7 percent on the day at $1.3318.

Still, Draghi didn’t rule out a proposal up for discussion tonight that would channel about 150 billion euros ($200 billion) from national central banks into the IMF’s crisis- fighting war chest. Euro-area governments expect central banks of non-euro EU countries to chip in 50 billion euros more.

The ECB provided breathing space today, trimming its main interest rate by a quarter-point to 1 percent and pledging to offer commercial banks unlimited cash for three years to tide them through the crisis.

Treaty Change

ECB measures sought to alleviate the impact of the debt crisis on the banking system, now in need of 114.7 billion euros in fresh capital, according to a European Banking Authority announcement today. European lenders will have to raise a total of 8 billion euros more than estimated by the EBA in October.

With Greece, Ireland and Portugal drawing on a combined 256 billion euros in European and IMF loans and Greece counting on 130 billion euros more, the government leaders’ focus shifted to preventing future budgetary crackups by reinforcing a “stability pact” that Germany conceived in the 1990s and watered down in 2005.

“What’s important for me is that the euro can only win back its credibility if we change the treaties a way that develops toward a stability union,” Merkel said before the summit. “That’s what at the core here for me.”

Marching in lockstep with Merkel, Sarkozy pressed for national balanced-budget amendments, ironclad barriers against excessive deficits and debt, and new powers for European authorities to dictate budgets in countries that overstep the limits. The tougher system, to be anchored in European treaties, would go beyond crisis-triggered rules that take effect next week.

‘More Solidarity’

Their task has been complicated by Standard and Poor’s decision to issue a downgrade warning for 15 euro-area governments pending the summit outcome.

“We need more solidarity in the euro zone and more discipline,” Sarkozy said at a pre-summit meeting of conservative leaders in Marseille. Europe is in an “extraordinarily dangerous situation.”

In a joint letter to European leaders yesterday, Merkel and Sarkozy set a March 2012 deadline for an agreement on treaty amendments, calling on euro states to set up their own fiscal- enforcement system in the absence of an accord among all 27 EU governments.

That go-it-alone threat plus a call for a financial transaction tax set up a showdown with U.K. Prime Minister David Cameron, head of the biggest EU country still using its own currency. Cameron comes to Brussels vowing to defend London’s status as Europe’s premier financial market.

‘Britain’s Interests’

“We need obviously to get that stability in the euro zone that’s good for European countries, good for Britain as well,” Cameron said on his way into the summit. “But also we need to protect Britain’s interests.”

A consensus is emerging to speed the setup of a permanent rescue fund, the 500 billion-euro European Stability Mechanism. It is likely to go into operation in late 2012, instead of mid- 2013 as originally planned, the EU diplomat said. No decision is likely tonight on combining it with the current rescue fund, the 440 billion-euro European Financial Stability Facility, the diplomat said.

In a concession by Germany, the revamped permanent fund will follow IMF practices on imposing potential losses on holders of bonds of debt-ridden states. Merkel agreed in yesterday’s letter that the two writedowns imposed on Greek bondholders this year were “unique and exceptional.”

National sensitivities pervade the negotiations, such as Finland’s objection to scrapping the unanimity rule for decisions by the fund to grant aid packages.

U.S. Treasury Secretary Timothy F. Geithner, on the final leg of a three-day trip to Europe, has urged policy makers to work with central banks to erect a “stronger firewall.”

“The leaders of Europe are moving this week to strengthen the foundations of monetary union,” Geithner said after talks with Italian Prime Minister Mario Monti in Milan. “These are vital and critical but also very challenging reforms. And they will take time.”

To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; Stephanie Bodoni in Brussels at

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net