EU leaders press Italy for reform at crisis summit (Reuters)

BRUSSELS (Reuters) – European Union leaders piled pressure on Italy on Sunday to speed up economic reforms to avoid a Greece-style meltdown as they began a crucial two-leg summit called to rescue the euro zone from a deepening sovereign debt crisis.

The aim is to agree by Wednesday on reducing Greece's debt burden, strengthening European banks, improving economic governance in the euro area and maximizing the firepower of the EFSF rescue fund to prevent contagion engulfing bigger states.

Before the 27 leaders began talks on a comprehensive plan to stem the crisis, German Chancellor Angela Merkel and French President Nicolas Sarkozy held a private meeting with Italian Prime Minister Silvio Berlusconi, officials said.

Diplomats said they wanted to maximize pressure on Rome to implement structural labor market and pension reforms to boost Italy's economic growth potential and reassure investors worried about its huge debt ratio, second only to Greece's.

A German government source said Merkel and Sarkozy underlined "the urgent necessity of credible and concrete reform steps in euro area states," without which any collective EU measures would be insufficient.

Merkel warned in a speech on Saturday that if Italy's debt remained at 120 percent of gross domestic product "then it won't matter how high the protective wall is because it won't help win back the markets' confidence.

Arriving for Sunday's sessions of the full EU and the 17-nation euro zone, the leader of Europe's most powerful economy played down expectations of a breakthrough, telling reporters decisions would only be taken on Wednesday.

Before then, Merkel must secure parliamentary support from her fractious center-right coalition in Berlin for unpopular steps to try to save the euro zone.

European Council President Herman Van Rompuy, chairing the summit, painted a somber picture of the economic challenges facing Europe in his opening remarks, citing "slowing growth, rising unemployment, pressure on the banks and risks on the sovereign bonds."

"Our meetings of today and Wednesday are important steps, perhaps the most important ones in the series to overcome the financial crisis, even if further steps will be needed," he said.

LIFELINE

Finance ministers made progress at preparatory sessions on Friday and Saturday, agreeing to release an 8 billion euro lifeline loan for Greece and to seek a far bigger write-down on Greek debt by private bondholders.

They also agreed in principle on a framework for recapitalizing European banks, which banking regulators said would cost just over 100 billion euros, to help them withstand losses on sovereign bonds, although some details remain in dispute.

Sarkozy, who disagreed sharply with Merkel over strategy last week, pressing to put the European Central Bank in the front line of crisis-fighting, said after meeting her again on Saturday he hoped for a breakthrough in the middle of the week.

"Between now and Wednesday a solution must be found, a structural solution, an ambitious solution, a definitive solution," Sarkozy said. "There's no other choice."

Asked whether he was confident of a deal, he replied: "Yes, otherwise I wouldn't be here."

The key outstanding issues were how to make Greece's debt burden manageable and scale up the euro zone rescue fund to shield Italy and Spain, the euro area's third and fourth largest economies, from bond market turmoil that forced Greece, Ireland and Portugal into EU-IMF bailouts.

Markets are concerned that Greek debt, forecast to reach 160 percent of GDP this year, will have to be restructured, but investors do not know what kind of damage they will have to take on their Greek portfolios.

The size of the losses private bond holders would have to suffer was the first issue that will be discussed on Sunday.

A debt sustainability study by international lenders showed that only losses of 50-60 percent for the private sector would make Greek debt sustainable in the long term.

This is much more than a 21 percent net present value loss agreed with investors on July 21 and some officials question whether it can be achieved voluntarily, or only through a forced default that would trigger wider market ructions.

Euro zone officials now argue the recession in Greece is much deeper than expected, the country is behind on privatization and fiscal targets and market conditions have deteriorated in the past three months.

To have enough money to support Italy and Spain, if needed, the euro zone wants to boost the firepower of its bailout fund, the 440 billion-euro European Financial Stability Facility.

But public opinion in many countries is strongly against more bailouts, and further commitments to the EFSF could drag down some countries' credit ratings, worsening the crisis.

How to raise the potential of the fund without new cash was probably the most contentious point to be discussed on Sunday, but not expected to be resolved until Wednesday.

France and several other countries would like the bailout fund to be turned into a bank so that it can get access to limitless financing from the European Central Bank. But Germany and the ECB itself are adamantly against that.

The most likely solution seems to be that the EFSF would guarantee a percentage of new borrowing of Spain and Italy in a bid to improve market sentiment toward those countries.

Such a solution might help ring-fence Greece, Ireland and Portugal, but some analysts say it could have perverse effects, creating a two-tier bond market in which secondary bond prices would be depressed, and removing the incentive for Italy to take politically unpopular action to cut its debt.

Another possibility under discussion is to create a special purpose vehicle that would enable non-euro zone countries and sovereign wealth funds to invest in government bonds, but EU officials are reluctant to give countries like China a seat at the euro zone table.

Unless European banks get more capital to cover potential losses on these bonds, other banks will be reluctant to lend to them on the interbank market, triggering a liquidity crunch, now prevented only by stepped-up ECB liquidity provisions.

The European Banking Authority told European Union finance ministers on Saturday that if all such bank assets were valued at market prices, EU banks would need 100-110 billion euros of new capital to have a 9 percent core tier 1 capital ratio, an EU source familiar with the discussions said.

Ministers agreed to give banks until June 2012 to achieve this capital ratio, first using their own funds or from private investors, and if that fails, by using public money from governments or as a last resort the EFSF.

With Italy, Spain and Portugal unhappy about the burden being placed on their banks, EU leaders were to discuss the issue on Sunday, but the source said it was unlikely an overall sum for recapitalization would be explicitly mentioned.

(Additional reporting by Andreas Rinke, John O'Donnell, Harry Papachristou, Illona Wissenbach; Writing by Paul Taylor)

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Big banks under pressure in Europe crisis (AP)

BRUSSELS – Big banks found themselves under pressure in Europe's debt crisis Saturday, with finance chiefs pushing them to raise billions of euros in capital and accept huge losses on Greek bonds they hold.

The continent's biggest financial institutions were at the center of talks as leaders entered marathon negotiations in Brussels, at the end of which they have promised to present a comprehensive plan to take Europe out of its crippling debt crisis.

"Between now and Wednesday we have to find a solution, a structural solution, an ambitious solution and a definitive solution," French President Nicolas Sarkozy said as he arrived in Brussels. "There's no other choice."

In addition to new financing for Greece, leaders want to make the banking sector fit to sustain worsening market turmoil and turn their bailout fund into a strong safety net that will stop big economies like Italy and Spain from falling into the same debt trap that has already snapped Greece, Ireland and Portugal.

But before the final deadline on Wednesday, they have to overcome many obstacles.

On Saturday, the finance ministers of the 27-country European Union decided to force the bloc's biggest banks to substantially increase their capital buffers — an important move to ensure that they are strong enough to withstand the panic that a steep cut to Greece's debt could trigger on financial markets.

A European official said the new capital rules would force banks to raise just over euro100 billion ($140 billion), but finance ministers did not provide details on their decision. The official was speaking on condition of anonymity because it had been agreed to let leaders unveil the deal at their first summit Sunday.

"We have made real progress and have come to important decisions on strengthening European banks," George Osborne, the U.K.'s chancellor of the exchequer, said as he left Saturday's meeting.

The deal on banks was likely to be the only major breakthrough ready to announce on Sunday, leaving many important decisions and negotiations to be completed by Wednesday night.

On Friday, the first day of the marathon talks, the finance ministers of the 17 countries that use the euro — and which have found themselves at the center of the crisis because of the currency they share — agreed to demand Greece's private creditors take big losses on their bondholdings.

But they still have get the banks to come along and convince them that the cuts are the best way to ensure that Athens can eventually repay its remaining debts.

The picture in Greece, whose troubles kicked off the crisis almost two years ago, is bleaker than ever. A new report from Athens' international debt inspectors — the European Commission, the European Central Bank and the International Monetary Fund — proved that a preliminary deal for a second package of rescue loans reached in July is already obsolete.

That plan would have seen banks and other private investors take losses of some 21 percent on their Greek bond holdings, while the eurozone and the IMF were to provide an extra euro109 billion ($150 billion) in bailout loans.

But the report showed that in the past three months Greece's economic situation has deteriorated so dramatically that for the bank deal to remain in place, the official sector would have to provide some euro252 billion ($347 billion) in loans. Alternatively, to keep official loans at euro109 billion ($150 billion), banks would have to accept cuts of about 60 percent to the value of their Greek bonds.

"I believe we are now arriving at a more realistic view of the situation in Greece," said German Chancellor Angela Merkel, the country that has long been advocating a more radical solution to Athens' problems.

But Merkel and her eurozone counterpart were on for tough negotiations with the banks.

Charles Dallara, who has been representing private investors in the talks with the eurozone, said Saturday that negotiations that carried on sporadically throughout Saturday were making only slow progress.

"We're nowhere near a deal," he told The Associated Press in an interview.

Dallara, the managing director of the Institute of International Finance — the world's biggest bank lobbying group — said current plans to cut Greece's debt would leave the country as "a ward of Europe" for years.

He declined to say how much in losses banks would be willing to accept, saying only "we would be open to an approach that involves additional efforts from everyone."

The eurozone has been working hard to reach a voluntary agreement with banks, rather than forcing losses onto the lenders, because that could avoid triggering billions of euros on payout for bond insurance and could destabilize markets even further.

However, in recent weeks some officials have no longer insisted that the deal remain voluntary.

Agreement on arguably the most important measure in the crisis plan remained even more elusive Saturday: boosting the firepower of the currency union's euro440 billion ($600 billion) bailout.

Increasing the effectiveness of the fund — called the European Financial Stability Facility — is meant to help prevent larger economies like Italy and Spain from being dragged into the crisis. At the same time, the EFSF may be asked to help governments shore up their banks if they can't raise the necessary funds on financial markets.

But Germany and France still disagree over how to give the EFSF more firepower. France wants the fund to be allowed to tap the ECB's massive cash reserves — an option that Germany rejects. Weaker economies, meanwhile, are wary of signing up to the other two parts of the grand plan — bigger bank capital and cuts to Greece's debt — without assurance that sufficient buffers are in place.

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Sarah DiLorenzo, Elena Becatoros, Raf Casert and Slobodan Lekic in Brussels contributed to this story.

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Eurozone crisis efforts in disarray amid divisions (AP)

BRUSSELS – Europe's efforts to solve its escalating debt crisis plunged into disarray Thursday, after Germany and France could not bridge their differences in time for a summit Sunday, forcing them to call a second meeting.

Sunday's summit was supposed to deliver a comprehensive plan to finally get a grip on the currency union's debt troubles by detailing new financing for debt-ridden Greece, a plan to make Europe's banks fit to sustain worsening market turbulence and a scheme to make the eurozone bailout fund more powerful.

The offices of French President Nicolas Sarkozy and German Chancellor Angela Merkel announced that they needed more time after it became clear that the currency union's two biggest countries could not agree on the main points of the plan.

Both governments said that all elements of the eurozone's crisis strategy would be discussed on Sunday "so it can be definitively adopted by the Heads of State and Government at a second meeting Wednesday at the latest."

It also said that the two leaders would meet Saturday evening ahead of the summit in Brussels in the hope of making progress.

"The chancellor is confident that in this way good, coordinated measures for the stability of the eurozone can be achieved," Merkel's spokesman Steffan Seibert told journalists in Berlin.

The announcement of a second summit is likely to increase concern over the eurozone's ability to stick together and stabilize the common currency. Sunday's summit had already been delayed from earlier in the week to give the leaders more time to agree on the key issues.

"The parochialism and procrastination that got us into this mess continues," said Sony Kapoor, managing director of economic think tank Re-Define. "Unless EU leaders pull a rabbit out of their hat now, this will worsen the already deep politico-economic crisis that Europe is facing."

European officials said ahead of the announcement that the eurozone remained deeply divided on important parts of its strategy on debt-ridden Greece, banks and its bailout fund.

Germany and several other rich countries have been pushing for banks and other private investors take steeper losses on their Greek bondholdings, before the eurozone can sign off on a second multibillion euro rescue package for the struggling country.

France and the European Central Bank have so far opposed forcing banks to write off more Greek debt, fearing that would destabilize the banking sector and worsen market turmoil.

But Greece's international debt inspectors warned earlier in the day that even under a rescue package tentatively agreed in July the country's debts were not sustainable.

In their statements Thurday, Merkel and Sarkozy said that — based on the inspectors' report — Greece should immediately start negotiations with the private sector to reach a deal "that would improve this debt sustainability."

The eurozone is also divided on how to give its bailout fund more firing power, with the French wanting the ECB to help out, which Germany opposes.

A third point of contention is how to fund expensive capital injections into weak banks that might take losses on Greek debt and have already taken a hit from falling prices of other government bonds. France and several other countries are worried that bailing out their banks could hurt their credit rating and want the bailout fund to support lenders directly, rather than lending first to governments.

Ahead of the announcement, one European official, who was speaking on condition of anonymity, suggested that the need for more time may also have been caused by disagreement between Merkel's government and the German parliament, which felt that decisions affecting taxpayer money were being taken over its head.

Seibert appeared to support that assessment, saying further changes to Europe's bailout fund would require the agreement of the Bundestag, the German parliament.

"A two-step summit allows for this to take place," Seibert said.

Merkel's address to parliament scheduled for Friday was canceled, and Seibert said it would take place next week.

Governments in rich and poor countries are finding it increasingly difficult to get their parliaments to support the common rescue efforts.

Greek lawmakers late Thursday barely passed a deeply resented austerity bill needed to get the next batch of rescue money and avoid a disastrous default next month.

But the vote further diminished the ruling Socialists' grip on parliament and triggered violent protests on the streets of Athens, leaving one person dead and dozens injured.

Tear gas choked the air in Athens' central Syntagma Square as riot police tried to separate more than 50,000 peaceful protesters from smaller groups determined to wreak havoc with firebombs and stones. The scene degenerated into running battles between groups of protesters beating each other and between helmeted, heavily armed police and masked rioters.

One central Athens hospital said it had treated 74 people injured in the clashes. Some of the injured were covered in blood from head wounds.

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Juergen Baetz and Melissa Eddy in Berlin, David McHugh in Frankfurt, Germany, and Nicholas Paphitis in Athens contributed to this report.

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Merkel, Sarkozy tackle differences over euro crisis (Reuters)

BERLIN (Reuters) – German Chancellor Angela Merkel will thrash out differences with French President Nicolas Sarkozy on Sunday over how to use the euro zone's financial firepower to counter a sovereign debt crisis threatening the global economy.

With the turmoil threatening to spiral into financial meltdown as the value of banks' sovereign bond holdings slide, Merkel and Sarkozy are likely to discuss in Berlin both how to manage Greece, prevent contagion and strengthen lenders.

The implosion of Belgian lender Dexia, the first victim of the crisis, has added a sense of urgency to the talks. The prime ministers of France and Belgium and the finance minister of Luxembourg agreed a rescue plan for Dexia on Sunday ahead of the stricken Franco-Belgian bank.

"Dexia will be among the topics that will be discussed but the main topic is Greece and the euro zone, as banks are only a consequence" of the crisis, a source at the French finance ministry told Reuters.

Sarkozy is due to arrive in Berlin late on Sunday afternoon and hold a meeting with Merkel followed by a working dinner. A news conference will take place at 1530 GMT.

Talks are continuing over a vital aid tranche for Greece, which could run out of cash as soon as mid-November. European finance ministers are considering making banks take bigger losses on Greek debt -- an issue that could be discussed at the Merkel-Sarkozy meeting.

"It is possible that we assumed in July a level of debt reduction that was too low," German Finance Minister Wolfgang Schaeuble was cited as saying by a newspaper on Sunday.

Separately, European Commission head Jose Manuel Barroso told Bild a Greek default would have unforeseeable consequences and may cause the crisis to spread.

"This is new territory for us and we are discussing solutions which have not really been tested before," he said.

BOLSTERING BANKS

Germany and France have so far been split over how to recapitalize Europe's banks, which Ireland estimated on Saturday may need more than 100 billion euros ($135 billion) to withstand the sovereign debt crisis, while the International Monetary Fund (IMF) has said the banks need 200 billion in additional funds.

Paris wants to tap the euro zone's 440 billion European Financial Stability Facility (EFSF) to recapitalize its own banks, while Berlin is insisting the fund should be used as a last resort.

Qatar is being cited by some media as a potential savior for European banks yet analysts believe tiny Gulf Arab state is an unlikely white knight, as Europe's needs are too great.

Top French banks BNP Paribas and Societe Generale denied a report on Sunday that they could seek to raise a combined 11 billion euros as part of a broader European bank recapitalization plan.

Another key dispute is how to use the EFSF to buy sovereign debt to prevent contagion of the crisis, particularly crucial if Greece fails to secure its next aid tranche.

France does not want to set guidelines for the EFSF on the matter, whereas Germany wants to limit the sum used for each member state and set a time limit for bond purchasing.

"Given that the EFSF is limited overall, it makes sense also to limit the purchases on the secondary market for each country," Michael Meister, deputy parliamentary leader of Merkel's conservatives, told Reuters.

There was a danger, otherwise, the funds could be quickly used up, he said.

Berlin could be prepared to allow a more flexible use of the EFSF to prop up states and banks if Paris agrees to a broad haircut on Greek debt, a German paper wrote on Sunday.

But a government source told Reuters: "There is no such agreement." Furthermore, Merkel warned last Tuesday that the threat of contagion from a euro zone country rescheduling its debt would be huge, and it only made sense once it had achieved a primary surplus again.

The two euro zone heavyweights have come under pressure worldwide to resolve Europe's crisis which is roiling markets. U.S. President Barack Obama on Thursday urged Europe to "act fast," calling the common currency bloc's crisis the largest obstacle to the United States' own recovery.

World Bank President Robert Zoellick told Wirtschaftswoche magazine there was a "total lack" of vision in Europe and Germany in particular needed to show more leadership.

Merkel will visit Vietnam and Mongolia this coming week.

(Additional reporting by Andreas Rinke in Berlin, Regan Doherty in Doha and Christian Plumb and Lionel Laurent in Paris, Editing by Hans-Juergen Peters)

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