EU Said to Weigh Using Bailout Fund

European officials are considering steps previously rejected by Germany, including the use of precautionary credit lines, to prevent the spread of the region's debt crisis, a person close to the talks said.

Other options up for discussion at tomorrow's Brussels summit include enabling the main 440 billion euro ($626 billion) rescue fund to lend to recapitalize banks, said the person, who declined to be named because negotiations are in progress. Nothing will be decided until leaders convene.

Together with a second Greek aid package, the goal is to prove to markets that Europe has the will and the tools to prevent the 21-month sovereign debt crisis from engulfing Spain and Italy. The euro today rose against the dollar for a second day and Spanish and Italian bonds also gained as investors signaled optimism that policy makers are moving toward a deal.

“There needs to be a program with a certain amount of shock and awe to impress the market that the leaders are on top of the crisis,” said Robin Marshall, a London-based money manager at Smith & Williamson Investment Management in London.

The start of tomorrow's summit was delayed by an hour to 1 p.m. to allow more time for preparations, an EU official said. A working group meeting of euro-area officials was also pushed back to 9 a.m. tomorrow from 6 p.m. today, the official said, speaking on condition of anonymity because negotiations are still underway.

Pressure on Merkel
Talk of new rescue measures raises the pressure on German Chancellor Angela Merkel, who vetoed proposals to put more weapons in the rescue fund's arsenal earlier this year amid misplaced optimism that Greece was turning the corner.

Merkel will meet today with French president Nicolas Sarkozy, who has swayed her stance on crisis-fighting in the past. U.S. President Barack Obama weighed in yesterday on a phone call with his German counterpart during which they agreed Europe needed to deal with its problems “effectively.”

Discussions of more flexibility for the European Financial Stability Facility come on the heels of last month's accord to boost its lending power to its original target. International Monetary Fund-style credit lines would better able countries with stronger fundamentals than Greece to ward off speculative attacks.

Stress Tests
Rescues for Ireland and Portugal partly funded by the EFSF already include some funds for helping banks, while Greece's separate program also earmarks aid for its banks. Greater support for European banks may be necessary after stress tests on 90 left as many as 24 under pressure to show they can raise capital. Investors said Deutsche Bank AG, UniCredit SpA and Societe Generale SA should consider boosting capital after scraping through the probes.

As floated by finance ministers on July 11, the leaders will also look at empowering the EFSF to buy bonds in the secondary market and to enable crisis-hit countries to buy back their own debt, measures that may help reduce nations' borrowing burdens. Spanish Finance Minister Elena Salgado, who is battling to prevent the crisis from engulfing her country, today said she supported such steps.

The extra yield that investors demand to hold 10-year Spanish bonds over German bunds rose to a euro era record of 367 basis points on July 18. The Italian spread hit 332 basis points.

'Make-or-Break'
With Greek Prime Minister George Papandreou saying in an interview yesterday that leaders face a “make-or-break” moment at the summit, success hinges on going beyond a second Greek package, which national officials continue to work on today. The IMF said yesterday that Greece's crisis still risks contaminating the rest of the euro region even if officials avert a default there.

The main sticking point is how to get bondholders and banks to foot a share of the bill without sparking a new wave of financial turmoil. European Central Bank President Jean-Claude Trichet says any default risks sparking a crisis on a par with the collapse of Lehman Brothers Holdings Inc. German policy makers, who are reluctant to keep forcing their taxpayers to aid the spendthrift, signal a restructuring may be unavoidable.

EU officials are aiming to narrow down a list of options to be presented to the leaders in Brussels, the person familiar with the talks said. Sarkozy and Merkel will meet for talks and dinner in Berlin, repeating the one-on-one talks the leaders of the two-largest euro-area economies have adopted in the past when trying to steer their region out of trouble.

One approach would see governments taxing financial institutions to fund a new bailout in addition to a voluntary rollover of Greek debt, according to an EU paper obtained by Bloomberg News. The other two options in the document involve either a partial or outright default.

Bloomberg News

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