Europe scrambles to save euro (AP)

by GREG KELLER and PAN PYLAS, AP Business Writer Greg Keller And Pan Pylas, Ap Business Writer – 7?mins?ago

PARIS – European leaders raced Monday to save the euro from impending breakup, as momentum gained for a radical proposal in which countries that use the common currency would cede control of a big chunk of their budgets to a central authority.

In the run-up to the next European summit on Dec. 9, hopes were rising that, with their backs to the wall, leaders will finally come up with a solution that will once and for all bring an end to a crisis that has threatened to wreck the global economy.

A raft of hitherto taboo ideas gained sudden prominence Monday.

Chief among them: a fast-track move to a fiscal union between the 17 countries that share the euro — a proposal some say would be a big leap toward a United States of Europe. Such a move could greatly enhance European stability, but at a cost, critics say, of national sovereignty and democratic accountability.

Another plan being aired in the face of fierce German resistance is for the eurozone's six triple A rated nations to pool their resources through a joint bond to prop up some of the single currency bloc's most indebted members. Germany, the EU's richest member, rejects the idea because it fears it would be tapped for the lion's share of the bailout.

Markets rallied Monday amid optimism for a bold breakthrough.

The Stoxx 50 index of leading European shares closing up 3.6 percent and the euro rising 0.4 percent to $1.3337. Bonds yields which rose alarmingly last week stabilized.

"There appears to be a sense of greater urgency among eurozone leaders after some very worrisome developments last week," said Vassili Serebriakov, an analyst at Wells Fargo Bank.

A critical test comes Tuesday when European finance ministers meet for a summit in Brussels and Italy tries to tap markets for billions more in cash. U.S. President Barack Obama was meeting top EU officials Monday at the White House to discuss the crisis.

Whatever materializes, the euro is in grave danger — with experts saying the currency could fall apart within days without drastic action.

Such a breakup could have catastrophic effects around the global economy. Among the unappetizing prospects are massive bank runs, the seizing-up of the global financial system, and chaotic currency fluctuations for those that go back to their historic money.

Bankruptcies could cascade across the continent with euro-denominated contracts plummeting in value overnight. If Germany broke from the euro, its national currency would skyrocket, severely damaging its export-oriented economy. If struggling Greece or Italy left, their currencies would plummet — making them unable to repay their euro-based debts.

The result for the world economy could be worse than the fallout from the 2008 Lehman Brothers collapse.

"Everyone knows that if the eurozone crashes the consequences would be very dramatic and in the race after that there would no winners, just losers," said Finland's finance minister Jutta Urpilainen.

Evolution Securities economist Gary Jenkins said a series of government bond auctions this week "may determine the future of the EU."

Financial Times columnist Wolfgang Munchau wrote Monday that the common currency "has 10 days at most" to avoid collapse and big decisions need to be taken, including moves to a fiscal union and the creation of a common treasury with wide-ranging powers.

As experts predicted the endgame for the euro, Europe buzzed with talk of a central treasury authority for the eurozone — an idea that just a week ago would have seemed impossible.

Unlike the United States, which has centralized institutions in Washington D.C. for raising taxes and spending, the eurozone has 17 independent treasuries with little oversight from Brussels. That would change under the fiscal union proposal being aired ahead of the EU leaders' summit in less than two weeks.

While not explicitly backing such a move, Germany and France, the eurozone's two biggest economies, have promised to propose new measures that will make the 17 operate under strict and enforceable rules — the hope being that no country, however small, can wreak such damage again.

The idea of fiscal union is controversial not least because it raises fears among some members that economic policy around Europe will be run by the EU's biggest player: Berlin.

But with Europe on the brink, it may be a price that many nations are willing to accept.

Already, the Paris-based OECD is warning that the global economy is in for a hugely rocky road over the coming months ahead. In its half-yearly report Monday, it said the continued failure by EU leaders to stem the debt crisis that has spread from Greece to much-bigger Italy "could massively escalate economic disruption" and end in "highly devastating outcomes."

The latest bout of turmoil to afflict the eurozone came last week after Germany failed to raise all the money it wanted in a bond auction and Italy had to pay through the roof to get investors to part with their cash.

If a busy bond schedule this week meets — Italy is planning to raise euro8 billion ($10.7 billion) on Tuesday — with an equally poor reception, then the euro's countries will be in real danger of being locked out of international markets and facing the devastating prospect of defaulting on their debts.

Germany, as Europe's only powerhouse economy, would then have to decide whether to bail its partners out — or bail out itself.

As governments nervously tap bond markets, Germany appeared to be readying to ask its eurozone partners to back measures for deeper fiscal union.

"The common currency has the problem that the monetary policy is joint, but the fiscal policy is not," Germany's Finance Minister Wolfgang Schaeuble said in a meeting with foreign reporters in Berlin. "Consequently, we are working now to expand the common currency through a common stability policy."

Schaeuble said the proposal, which Chancellor Angela Merkel is to bring up during the Dec. 9 EU summit, would only require passage by the 17 eurozone member states, although the other ten EU countries, such as Poland and Sweden, would be welcome to adopt it if they wanted.

However, analysts said such a move would take a long time to come to fruition.

"We do seem to be moving slowly towards more of a fiscal union but at a pace that may result in all the components being put in place after a complete meltdown of the financial system," Evolution Securities' Jenkins said.

Many think the European Central Bank is the only institution capable of calming frayed market nerves and German Chancellor Angela Merkel's continued dismissal of a greater ECB role has frayed market nerves.

"The ECB has the means to provide a credible measure to avoid further contagion in the sovereign bond markets," the OECD's Chief Economist Carlo Padoan said. "And if you ask me if that is the lender of last resort function, I would say yes."

Potentially, the ECB has unlimited financial firepower through its ability to print money. However, Germany finds the idea of monetizing debts unappealing, warning that it lets the more profligate countries off the hook for their bad practices. In addition, it conjures up bad memories of hyperinflation in Germany in the 1920s.

So far, the ECB has been reluctant in taking on a bigger firefighting role. Current rules only allow it to buy up government bonds in the markets on condition that it sells an equivalent amount of assets.

Though figures Monday showed that it stepped up its purchases in the markets last week to euro8.6 billion ($11.48 billion) from euro8 billion ($10.68 billion) the week before, analysts think that's not enough to keep a lid on countries' borrowing rates. Italy's main ten-year bond yield stands at over 7 percent, the threshold that eventually proved too costly for Greece, Ireland and Portugal and led them to seek financial help.

One proposal that's often been touted as another key pillar of a long-term solution is the issuance of eurobonds, whereby the 17 euro nations pool together to raise money in the markets. Again though, Germany has opposed the principle of eurobonds since it would expose its taxpayers to the bad debt of weaker countries.

A variant of that emerged Monday with a report in Germany's Die Welt newspaper that the six eurozone countries with a triple A rating would issue bonds together. So-called "elite bonds" would be used to support the fiscally-endangered.

Germany's Schaeuble said the report was "completely made up."

____

Pylas reported from London. Melissa Eddy, Juergen Baetz, Kirsten Grieshaber and David Rising in Berlin, and Matti Huuhtanen in Helsinki contributed to this story.

Europe could be in worst hour since WWII: Merkel (Reuters)

LEIPZIG, Germany (Reuters) – German Chancellor Angela Merkel said on Monday that Europe could be living through its toughest hour since World War Two as new leaders in Italy and Greece rushed to form governments and limit the damage from the euro zone debt crisis.

A rally on financial markets sparked by the appointment of respected European technocrats in Rome and Athens soon stalled. Analysts warned that daunting obstacles could hinder decisive action needed to breathe new life into their ailing economies.

Italy had to pay a euro-lifetime record yield of 6.3 percent to sell five-year bonds with investors wary of buying its debt until prime minister-designate Mario Monti can undertake profound economic reforms.

In a first sign of trouble for new Greek Prime Minister Lucas Papademos, the leader of the main conservative party rejected any toughening of austerity and refused to sign a letter sought by European authorities pledging support for a new 130 billion euro bailout.

Merkel dramatized the situation facing the euro zone in an attempt to rally her conservative party behind the government at a congress in Leipzig.

"Europe is in one of its toughest, perhaps the toughest hour since World War Two," she told her Christian Democrats (CDU), saying she feared Europe would fail if the euro failed and vowing to do anything to stop this from happening.

In a one-hour address, Merkel called for closer European political union but offered no new ideas for resolving the crisis that has forced bailouts of Greece, Ireland and Portugal, raising fears about the survival of the 17-state currency zone.

European Union governments have until a summit on December 9 to come up with the outlines of a much bolder and more convincing strategy, with some form of massive, visible financial backing.

Prospects are uncertain as the German government, the Bundesbank and hardliners in the European Central Bank have blocked key policy options. These include issuing common euro zone bonds, mutualising the euro zone's debt stock, letting the ECB create money to fight the crisis, or act as a lender of last resort, directly or via the euro zone rescue fund.

HIGH DRAMA IN ROME

In weekend drama, Italy's president asked Monti, a former European commissioner, to form a government to reverse a disastrous collapse of market confidence in an economy whose debt burden is too big for the euro bloc to bail out.

Italians sang, danced and drank champagne in the streets to celebrate the resignation of scandal-plagued billionaire Silvio Berlusconi, and an impromptu orchestra near the presidential palace played the Hallelujah chorus from Handel's Messiah.

The ECB has been buying troubled euro zone governments' bonds episodically to try to stabilize markets. But figures released on Monday showed it halved its weekly bond buy at the height of the Italian government crisis last week, suggesting it was no longer willing to help Berlusconi.

After a tumultuous week, when Italy's borrowing costs rose to the kind of levels that saw Ireland and Greece forced to seek international bailouts, initial market reaction was positive on Monday, with both stocks and bond markets lifted.

But in a sign of the fragile state of confidence, the trend was reversed after the Italian bond auction, and the release of figures showing industrial production slumped by 2 percent in the euro zone in September, raising the specter of recession.

"(Monti) is perceived to be a positive change for the country," said Annalisa Piazza, rate strategist at Newedge.

"Cautiousness on the future developments in Italy is fully justified. Credibility has been lost and it will take a while for market participants to believe that the country is back on the right track."

Monti held talks with political parties on Monday before separate meetings with trade unions and employers on Tuesday, as he moves to appoint what is expected to be a relatively small cabinet made up of experts from outside parliament.

He went to work after a frenetic weekend in which Italy's parliament approved a package of economic reforms agreed with European leaders, clearing the way for Berlusconi to resign.

"Monti spoke about a significant program with many sacrifices," Francesco Nucara, a lawmaker from one of the myriad tiny parliamentary groups involved in the talks, said after meeting the prime minister designate.

"IT DOESN'T END HERE"

But some were skeptical about the strategy to reverse the collapse of market confidence in Italy.

"It doesn't end here" read a headline in Libero, a fiercely pro-Berlusconi daily which said that "the Left and its newspapers may have uncorked the champagne too early".

While Italy's problems and the long-drawn-out departure of Berlusconi have pushed the collapse of the much smaller Greek economy backstage, IMF and European leaders will keep Papademos under pressure to implement radical reforms.

Papademos succeeded George Papandreou, whose proposal to hold a referendum on the bailout terms prompted EU leaders to raise the threat of a Greek exit from the currency bloc.

The new premier, who oversaw Greece's entry to the euro zone in 2002, must win a confidence vote on Wednesday before meeting euro zone finance ministers in Brussels on Thursday.

The Herculean task facing Papademos was illustrated on Monday when New Democracy leader Antonis Samaras said he would not vote for new austerity measures, adding that the policy mix of spending cuts and tax rises agreed with international lenders should be changed in favor of economic growth.

"I agree with the goals to cut government spending ... to reduce debt, to erase the deficit, to make structural changes. I do not agree with whatever stunts growth," he told party MPs.

Inspectors for Greece's international lenders, known as the troika, were due to meet the new administration of Papademos following Wednesday's confidence ballot but uncertainty surfaced over whether they would indeed come.

DISRUPTIVE DEMONSTRATIONS

Most Greeks hailed Papademos's appointment, but thousands of people angry at more than a year of austerity are expected to rally on Thursday, the anniversary of a 1973 student uprising that helped to bring down a 1967-1974 military junta.

That could complicate talks between the troika and the new cabinet, as the demonstration is expected to shut down central Athens and could be the biggest rally in months of protests that have at times erupted into bloody clashes.

"They may come at the end of the week but nothing is fixed," Carlos Martin Ruiz de Gordejuela, spokesman for the European Commission's mission in Greece, said of the troika team, which had been expected to arrive early in the week.

Monday's euro zone industrial production figures pointed to a sharp contraction toward the end of the year and the risk of a double-dip recession.

The slide in output at factories in the 17 nations sharing the single currency was the biggest fall since February 2009 -- when the economy was reeling from the worst financial crisis since the 1930s.

"It clearly doesn't bode well for the future," said Francois Cabau, an economist at Barclays Capital. "If we don't see some resolution of the euro zone sovereign debt crisis, business confidence could go even lower."

(Additional reporting by Philip Pullella and James Mackenzie in Rome, Ben Harding and Harry Papachristou in Athens, Eva Kuehnen in Frankfurt, Alexandra Hudson in Berlin and Robin Emmott in Brussels, writing by Peter Millership; Editing by Paul Taylor)

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Commentary says China not a "savior" for Europe (Reuters)

BEIJING (Reuters) – Europe should not expect China to ride to the rescue as its "savior" from the debt crisis, though Beijing will do what it can to help a friend in need, state-run news agency Xinhua said in a commentary on Sunday.

The head of Europe's rescue fund sought to entice China on Saturday to invest in the facility by saying investors may be protected against a fifth of initial losses and that bonds could eventually be sold in yuan if Beijing desires.

Though China has expressed confidence that Europe can survive its crisis, it has made no public offer to buy more European government debt.

Xinhua, in an English-language commentary, said China could not stand by while its largest trading partner foundered.

"Beijing's good-will gesture is a good response to those who see China as a threatening rival to Europe. Despite differences in politics, economy and culture, China and the EU are still good friends and partners," it wrote.

"However, amid such an unprecedented crisis in Europe, China can neither take up the role as a savior to the Europeans, nor provide a 'cure' for the European malaise," Xinhua added.

"Obviously, it is up to the European countries themselves to tackle their financial problems. But China can do within its capacity to help as a friend."

Such commentaries offer an insight into government thinking, even if they do not reflect official policy.

China's pile of $3.2 trillion in foreign exchange reserves, the biggest in the world, keeps growing thanks to trade surpluses and capital inflows.

Analysts estimate that China holds about a quarter of its foreign exchange in euro assets and there are few other places for it to park investments of such a scale.

The government has said it has confidence in the euro and in the European Union's efforts to tackle the crisis. But comments from Chinese economists and in state media have also revealed anxieties about the security of euro assets.

Expanding the European Financial Stability Facility (EFSF) to 1 trillion euros is key to the euro zone's latest anti-crisis plan, put together at a Eurozone summit last week.

Details on how this would be done have yet to be finalized and European leaders are under pressure to show the plan will work.

Xinhua said Europe needed to make "more concerted efforts".

The G20 summit in Cannes next month should accord China the respect it deserves, the commentary added.

"It is advisable that at the summit European leaders take heed of the voices of emerging economies, whose remarkable contribution to world economic recovery and growth deserves better understanding and reciprocal treatment."

(Reporting by Ben Blanchard; Editing by Ron Popeski)

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Europe eyes bolstering banks ahead of debt storm (Reuters)

DUBLIN/FRANKFURT (Reuters) – European banks may need more than 100 billion euros ($135 billion) to withstand the sovereign debt crisis, Ireland estimated on Saturday ahead of a meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy to work out how to recapitalize the lenders.

The falling value of banks' holdings of government debt from Greece and other euro zone periphery states has already prompted the implosion of Belgian lender Dexia, adding urgency to the Merkel-Sarkozy talks on the crisis.

Germany and France have so far been split over how to strengthen shaky lenders and fight financial market contagion that may follow a possible Greek default.

Paris is keen to tap the euro zone's 400 billion rescue fund, the EFSF, to recapitalize its own banks, while Berlin is insisting the fund should be used as a last resort.

The International Monetary Fund (IMF) has said European banks need 200 billion euros in additional funds.

Irish Finance Minister Michael Noonan said the capital needed to bolster banks cushions was likely to come from a variety of sources but the bill would be large.

"I think there is general agreement that it will be significantly in excess of 100 billion (euros)," Noonan told reporters on the sidelines of an economic forum in Dublin.

"I know that some of the big German banks that I was talking to personally intend raising money on the market so it will be private funding. Other banks would like to avail of the EFSF fund. Other banks will rely on their sovereign governments to provide the capital so there is going to be a range of ways of doing it," he said.

Regulators worry that forcing a raft of major lenders to take state aid would not be the best use of Europe's capital resources, while banks fear than singling out only some lenders for extra support could heighten market worries about weaknesses at individual banks.

German newspaper Frankfurter Allgemeine Zeitung on Saturday cited financial sources as saying France's five-biggest lenders would agree to take 10-15 billion euros in funding from the French state but also wanted to see Germany's No. 1 lender Deutsche Bank plump its capital cushion.

Deutsche Bank Chief Executive Josef Ackermann is against any role for the state in his own bank's capital position and has ruled out a capital increase.

A Deutsche Bank spokesman on Saturday referred to Ackermann's long-standing public position and declined further comment.

Sarkozy is due to arrive in Berlin late on Sunday afternoon and hold a working dinner with Merkel in the evening, amid signs that conditions for resolving the crisis are getting no easier.

Slovakia's coalition government was in deadlock on Saturday over talks on ratifying a strengthening of the EFSF rescue fund, with a junior party insisting on conditions for its support.

Euro zone minnows Slovakia and Malta are the last countries holding up expansion of the EFSF mandate, which is needed to fight the sovereign debt crisis.

Meanwhile, Greece's representative at the IMF said the country's borrowing needs will be higher than currently projected due to a tougher-than-expected recession and the outcome of a debt agreement with private sector creditors.

"This financing gap will have to be covered either by increasing the 109 billion euro loan agreed on July 21 or through a restructuring of private debt," Panagiotis Roumeliotis said in an interview in financial daily Imerisia.

EU leaders agreed in July to provide Greece with a second bailout of more than 109 billion euros to help the country service its debt through to 2020. ($1 = 0.741 Euros)

(Reporting by Jonathan Gould, Sarah Marsh, Carmel Crimmins, Lorraine Turner, Christian Plumb, Philip Blenkinsop and Andreas Rinke; Editing by Alison Birrane)

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Yields fall to 60-year lows on Europe worries (Reuters)

NEW YORK (Reuters) – Treasury debt prices rose on Friday, taking benchmark yields to the lowest in at least 60 years as investors looked for a safe haven on revived worries a European debt crisis could have a significant global impact.

Stocks plunged on Friday, losing over 2.5 percent and bolstering the safe-haven allure of U.S. government debt, with few investors looking to go into the weekend short Treasuries due to the uncertainty surrounding the European debt crisis.

The worries over Europe were sparked by the planned resignation of European Central Bank (ECB) Executive Board Member Juergen Stark. The ECB confirmed a Reuters report that said Stark was quitting because of a conflict over the central bank's bond buying program.

"The Stark resignation just kind of raises an eyebrow at a time when there's already concerns about what's going to happen next," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.

A debt swap meant to help Greece avoid default and win time to repair its tattered public finances hung in the balance Friday, with expectations of take-up by private creditors slipping amid fierce European pressure on Athens.

"There is a real danger that a European default or bank failure would lead to a global banking crisis akin to that seen after the fall of Lehman Brothers," said Paul Dales, U.S. economist at Capital Economics in Toronto.

Benchmark 10-year notes were trading 19/32 higher in price to yield 1.91 percent, down from 1.98 percent late Thursday. Benchmark yields touched 1.896 percent, marking the lowest since at least World War II.

"Stocks certainly took a brutal push there and we've had an awful lot of buying accumulate this morning on all of the bad news about Europe, so when we come in for a little more buying (of Treasuries) this morning there's just nowhere for prices to go -- they've got to keep going up," said Jim Vogel, is head of fixed income research at FTN Financial in Memphis.

The drop in yields stirred some concerns about Treasury debt auctions next week.

The Treasury will sell $32 billion of three-year notes, $21 billion of reopened 10-year notes and $13 billion of reopened 30-year bonds next Monday, Tuesday and Wednesday.

Some investors felt the Treasury may have a difficult time successfully auctioning the debt with yields at current low levels.

Longer-dated Treasuries have found support in recent days on expectations the Fed could announce a bond purchase program, which the markets have dubbed Operation Twist, at the conclusion of its policy meeting September 20-21.

A speech by Fed Chairman Ben Bernanke Thursday was generally seen as leaving the door open to the possibility of Operation Twist arriving soon. Bernanke said the U.S. central bank would spare no effort to boost weak growth.

Thirty-year Treasury bonds were trading 1-10/32 higher in price to yield 3.25 percent, down from 3.31 percent late Thursday.

(Additional reporting by Emily Flitter; editing by Andrew Hay)

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Analysis: Europe puts its head in sand over growth crisis (Reuters)

By Alan Wheatley, Global Economics Correspondent Alan Wheatley, Global Economics Correspondent – Mon?Sep?5, 4:19?am?ET

LONDON (Reuters) – Japanization is shorthand for slouching toward that country's noxious mix of low growth and high debt. Euro zone governments will find it tough to keep the ugly new word out of their lexicon.

Concern is mounting over a deterioration in Europe's long-term growth prospects that, unaddressed, will make it even harder to tackle the banking and debt problems underlying the current life-or-death struggle over the euro.

The financial crisis that has been rocking the global economy since 2008 has permanently reduced trend growth across the industrial world. The Organization for Economic Cooperation and Development in Paris reckons the potential output of its 34 member countries has dropped by about 2.5 percent.

"A lot of countries are going to take a permanent hit to their trend rate of growth. This is not an ordinary recession and so we're not going to see countries bouncing back to pre-crisis rates of growth," said Philip Whyte, a senior research fellow at the Center for European Reform, a London think-tank.

As firms have gone bust, capacity has been lost for good. With demand subdued, profitable companies are not replacing old plants.

And as high unemployment persists, skills atrophy. This weakens productivity and shuts people out of the job market for longer and longer periods -- a danger stressed by Federal Reserve Chairman Ben Bernanke at the U.S. central bank's Jackson Hole symposium last month.

Apart from sapping animal spirits and forcing governments to raise taxes or cut spending, diminished growth closes off one route for lowering the high sovereign debt to gross domestic product ratios that have locked Greece, Ireland and Portugal out of the bond markets and are unnerving investors in Italian and Spanish debt.

Against this background, and with the scope for fiscal and monetary stimulus all but exhausted, politicians might be expected to grasp the nettle and push through reforms to improve the supply side of the economy -- policies such as making it easier to hire and fire, promoting greater competition and investing more in training.

Far from it. Pier Carlo Padoan, the OECD's chief economist, says he is less optimistic about the prospects for deep-seated change than he was at the start of the year.

"I see that measures are being announced. I would like to see them being implemented," Padoan said.

With policy ammunition running desperately short, he said it was time for governments to overcome their squeamishness about confronting vested interests opposed to change. "This is a luxury that many countries cannot afford any more. The situation does not allow it."

SOUTHERN DISCOMFORT

The vicious circle of rising debt and falling growth is made worse by the fact that those countries drowning in debt on the periphery of the euro zone are also the ones that have dragged their feet on freeing up their product and labor markets or modernizing their education systems.

"They're going through some truly horrible times. I'm very worried about the whole southern European fringe, not just on an 18-month to 2-year view but looking out a decade or longer," said Whyte with the Center for European Reform.

Germany, by contrast, derided a decade ago as the sick man of Europe, is being held up as a model, at least when it comes to jobs.

"The remarkable resilience of the German labor market in the last few years, where wage moderation and flexible time accounting shielded the economy from excessive job destruction, illustrates admirably the promise of well-structured reforms," Jean-Claude Trichet, president of the European Central Bank, said approvingly in Jackson Hole.

How much are countries missing out by not pressing the reform button?

Padoan says Europe's trend growth has fallen in recent years to an average of just 1.5 percent a year, but he says some members of the 17-nation euro zone could almost double that rate with a supply-side jolt.

Italy needs to liberalize its service sector, open up professions to new entrants and improve energy efficiency, Padoan said. Greece needs to do all that and overhaul its labor market and competition policy at the same time.

POOR ADVERT FOR FREE MARKETS

Germany, too, could grow faster still if it liberalized services, which would trigger increased investment.

These policy prescriptions are well worn. Leaders of the European Union enshrined them and a host of other reform goals in the 2000 Lisbon Agenda, which they promptly ignored. The pledges have since been repackaged as the Europe 2020 Strategy, but Whyte says the havoc wrought by the near-collapse of the international financial system will make politicians more wary than ever of the social disruption that reforms entail.

"The Great Financial Crisis hasn't been a great advert for free-market capitalism," said Whyte. His research outfit publishes a booklet this week exploring how Europe could take off by embracing innovation. But in this area, too, Whyte fears the political climate means policy is likely to be increasingly hijacked by incumbent firms hostile to competition from start-ups.

Europe is not doomed to go down Japan's path of economic stagnation. Its potential growth rate is low but stronger than Japan's -- estimated by the Bank of Japan at just 0.5 percent a year because of a fast-shrinking working-age population.

But the specter of a renewed recession is a reminder for governments that, even if they can spirit away the euro zone's currency and debt woes, they have still to find the elixir for growth.

"I'm not saying politicians will implement reform, but they should," Padoan said. "Some politicians resist reform because they are captive to interest groups. Well, the price for those governments in terms of sustainable growth will be very high."

(Reporting by Alan Wheatley; Editing by Ruth Pitchford)

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Europe and U.S. should consider stimulating growth: IMF's Lagard (Reuters)

BERLIN (Reuters) – IMF chief Christine Lagarde said in an interview released on Sunday that Europe and the United States should consider stimulating economic growth, if the situation permits, to offset a crisis of confidence hitting the global economy.

"Looking at Europe, we recommend countries to adjust their austerity programs to a changed situation and consider measures to drive growth," news weekly Der Spiegel reported her as saying.

"If the United States launches a credible middle-term adjustment program, there is possibly room to abandon the short-term austerity measures and to introduce some measures to drive growth," she added.

Lagarde caused a stir last weekend when she urged policymakers to force Europe's banks to boost their capital or risk derailing a fragile global recovery, a call she reiterated in the interview.

European politicians last week rejected the call, which would involve raising up to 200 billion euros ($290 billion) in new capital, adding to fears that policymakers may be underestimating the severity of the debt crisis.

Turning to Germany, Europe's largest economy, Lagarde said its state finances were recovering well, hinting that Berlin may be well positioned to stimulate growth if it is hit by a downturn.

"It all depends on the circumstances, of course. If exports -- the foundation of the German economy -- collapse, the government could push back."

"If Germany stimulates domestic demand, it is good for the German economy and for its neighbors," she added, when asked if Germany should stimulate demand.

(Writing by Brian Rohan; Editing by Jon Loades-Carter)

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Wall St gains for 3rd day on M&A, Europe hopes (Reuters)

NEW YORK (Reuters) – Stocks gained for a third day on Monday after last week's wild swings on U.S. deal news and speculation European leaders may get control of the euro zone's debt problems.

The market's somewhat firmer footing follows weeks of volatility and a selloff that put the S&P 500 in negative territory for the year.

The benchmark index is still considered in a correction, having lost 12.6 percent since its April 29 highs due to concerns about U.S. fiscal policy, Europe's debt woes and the downgrading of the United States' top-notch credit rating.

Among the day's biggest gainers, Motorola Mobility Holdings Inc jumped nearly 57 percent to $38.25 on Google Inc's offer to buy the company for about $12.5 billion in cash. Google dropped 2.6 percent to $549.19.

"You're seeing kind of a reversal from last week in financials," said Thomas Villalta, portfolio manager for Jones Villalta Asset Management in Austin, Texas. That "speaks to underlying fundamentals" of the businesses involved.

But the sharp ups and downs of last week could return, he said, as Europe's concerns weigh.

"Europe has been extraordinarily slow in taking any sort of decisive action to improve perceptions ... that means to me we could have volatility through the end of the quarter."

A meeting on Tuesday by French and German political leaders was expected to result in initiatives needed to restore confidence in credit and other markets.

The S&P financial index rose 2 percent.

The Dow Jones industrial average was up 121.66 points, or 1.08 percent, at 11,390.68. The Standard & Poor's 500 Index was up 15.03 points, or 1.28 percent, at 1,193.84. The Nasdaq Composite Index was up 21.28 points, or 0.85 percent, at 2,529.26.

In other takeover news, Time Warner Cable Inc will buy cable operator Insight Communications from Carlyle Group for $3 billion in cash to broaden its presence in the Midwest. Time Warner declined 1.1 percent to $64.78.

(Reporting by Caroline Valetkevitch; Additional reporting by Rodrigo Campos; Editing by Kenneth Barry)

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Europe nears agreement on Greek crisis bailout (AP)

BRUSSELS – Greece would get some relief on part its massive debts and a Europe-wide rescue fund would gain new powers to swiftly aid other debt-stricken countries under a sweeping deal being negotiated by eurozone leaders Thursday.

Though the deal would likely trigger a temporary default by Greece — the first ever by a euro state — it could also help the ailing country emerge from its debt hole in the longer term and shake up Europe's way of handling the crisis, by making it more proactive.

Stocks, bonds and the euro rallied sharply on hopes that the deal will be a turning point in the eurozone's 18-month debt crisis. Growing market panic has weighed on the single currency and forced already bailed out Greece, Portugal and Ireland as well as struggling Spain and Italy to make billions of euros in cuts.

A draft of the deal seen by The Associated Press said that banks and other private investors that own Greek bonds have agreed to contribute to the rescue of the country — language indicating that they will accept being paid back more slowly or at lower interest rates.

This could happen through banks trading their current bonds to Greece for new ones that mature years later. The banks could also sell their bonds back to Greece at a loss.

Ratings agencies have long warned that such measures would be seen as a form of Greek default on its loans, a first for a eurozone country and a potential cause of devastating loss of confidence in the other heavily indebted nations.

Markets appeared to be seeing the draft measures as less harmful than expected, however, fueling the rally.

"Greece is in a uniquely grave situation. This is the reason why it requires an exceptional solution," the draft says.

The draft deal, if approved, would also radically overhaul a bailout fund created last year after Greece was bailed out with euro110 billion ($156 billion) in rescue loans by the other eurozone countries and the International Monetary Fund. Like Greece, Ireland and Portugal have since found themselves increasingly unable to sell bonds with sharply higher rates demanded by investors frightened that their struggling economies would leave them unable to repay their debts.

But so far the European Financial Stability Facility could only be tapped once a country was on the brink of financial collapse and after it agreed to huge cuts and changes to the way its economy is run.

The deal would now allow the EFSF to intervene pre-emptively, before a country is in full-blown crisis mode.

For instance, countries could be given a "precautionary program," likely some form of credit line. That might allow states under stress, like Spain, to continue raising money on the markets, giving an extra assurance to investors, and could also make it easier for Ireland and Portugal to re-enter the markets once their bailout programs expire.

Money from the EFSF could also be used in some situations to recapitalize banks in countries that have not yet been bailed out, the draft says.

On top of that, the draft says, the EFSF could be authorized to buy up bonds of troubled countries on the open market, maintaining the prices of the bonds and keeping their interest rates from skyrocketing in the face of pressure from worried investors.

A eurozone official told The Associated Press that the draft was "definitely not final" and that "anything can change," speaking on condition of anonymity because of the sensitivity of the negotiations.

Even though initial market reaction to the draft deal was positive, the euro traded up 0.8 percent at $1.4371 after it had slumped earlier in the day, analysts warned that it won't constitute a turning point in the eurozone's debt travails.

"From what we can see, there are still couple of major shortcomings," Jonathan Loynes, chief European economist at Capital Economics in London, said in a note. The deal would reduce Greece's near-term financing needs, but won't significantly lower the overall debt burden, Loynes said, adding that "there is no 'shock and awe'," that would boost market confidence in the eurozone as a whole.

A major fear about a potential Greek bond default has been the potential for massive disruption to the Greek banking system. Greek banks use Greek government bonds that they own as collateral for short-term loans they receive from the European Central Bank.

That money funds the banks' day-to-day operations, including short-term loans to private businesses.

A default would render the bonds useless as collateral, causing that funding to dry up and wreaking havoc on the Greek economy.

To prevent that, the eurozone could provide some form of repayment guarantee or collateral for the new Greek bonds banks would take on, the draft says.

According to the draft, the eurozone and the International Monetary Fund are also ready to give new rescue loans to Greece, without providing a number.

Eurozone leaders also plan to ease the loan conditions for their part of the bailout, by doubling the average loan maturity for Greece to at least 15 years from 7 1/2 years currently and reduce the interest rate to 3.5 percent.

Those softer loan conditions would also apply to Ireland and Portugal.

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No consensus as Europe limps toward Greece summit (Reuters)

BRUSSELS/PARIS (Reuters) – European government officials and commercial bankers struggled to reconcile competing proposals for a second bailout of Greece on Monday, just three days before a summit meeting called to prevent the crisis from spreading through the region.

French government spokeswoman Valerie Pecresse said she believed the summit of the euro zone's 17 national leaders scheduled for Thursday in Brussels would agree on a rescue of Greece, supplementing a 110 billion euro ($154 billion) bailout launched in May last year.

But after three weeks of preparatory talks, it was unclear how a consensus could be reached on a way for private owners of Greek government bonds -- banks, insurers and other investors -- to contribute to the bailout by taking cuts in the face value of their holdings.

Imposing a small tax on all euro area banks is under active consideration as a possible alternative to more risky forms of private sector involvement, a source familiar with the talks said, confirming a German media report.

The source also said officials were considering measures to try to prevent the fallout from the Greek crisis from damaging financial markets globally.

Fears that the rescue of Greece might fail, leading eventually to a disorderly debt default, pushed the euro down against other currencies and bond yields of highly indebted euro zone governments rose. Italy's 10-year yield climbed over 0.2 percentage point to a euro-era high.

Paul de Grauwe, a professor of international economics at Leuven University in Belgium who has informally advised European Commission President Jose Manuel Barroso, said politicians had delayed taking decisive action on Greece for so long that their options were narrowing fast.

"I'm afraid to hope. I still hope, yes, but I'm not optimistic," he said.

"We've had solutions in the past, but we haven't grasped them. Now it's too late for some of those solutions to work anymore; the opportunity has been lost."

RANGE OF SCHEMES

Officials are wrestling with a range of proposed schemes for Europe's bailout fund, the European Financial Stability Facility, to finance a voluntary buy-back or swap of Greek bonds, or possibly both. The schemes would be conducted at a discount to the bonds' face value, helping to reduce Greece's 340 billion euro mountain of sovereign debt.

But all of the schemes could face technical and legal obstacles, in some cases requiring the approval of national parliaments in the euro zone, and they risk fuelling market instability if credit rating agencies respond by declaring Greece in limited default.

The source familiar with the negotiations said the tax on banks, which might substitute for those schemes, could raise 10 billion euros a year, yielding 30 billion euros over three years -- the sum which Germany and other countries have set as the benchmark for the private sector's contribution.

Asked about the apparent unfairness of making banks not exposed to Greek debt share the burden with those that do have exposure, the source said the tax could be structured to fall mainly on investors with the most exposure. He did not say how.

"This has been discussed for a few weeks but never really got momentum. Lately it's been getting a bit more. The Germans say they are not against it. It would be a form of private sector involvement without the collateral damage of triggering a credit event or a selective default," the source said.

But any contribution by the private sector is unlikely to be nearly enough to solve Greece's problem. Analysts have estimated its debt would need to be roughly halved, to 80 percent of gross domestic product, to make it manageable in the long run.

A bond swap might have the most impact.

But a European Union official source told Reuters that any agreement on a swap this week would probably be quite small, merely paving the way for a debate on a bigger restructuring of Greek debt that would have to take place in a few months' time.

"What we're talking about down the road is the need for a massive reduction in the debt burden, and they are just not ready to do that yet," said Guntram Wolff, deputy director of the Bruegel think tank and previously a senior economist at DG Ecfin, the European Commission unit dealing with the crisis.

"It will require some form of substantial debt restructuring and you have to see who is going to take the hit, will it be the taxpayers or will it be the banks? To carry out such a move you need to prepare, and they don't have the time to prepare before Thursday."

BAILOUT

As part of the second bailout, officials have also been looking at other measures to help Greece including up to 60 billion euros of additional emergency loans from European governments and the International Monetary Fund; steps to recapitalize Greek and European banks; and ways to stimulate Greek economic growth.

EU sources said there was a basic agreement on extending the maturities and lowering the interest rates for bailout loans extended to Greece, Ireland and Portugal. Greece's EU loans have maturities of about 7.5 years with a rate of 4 percent; their length might be doubled or even quadrupled, and the rate cut by at least 0.5 percentage point.

But de Grauwe said the mood of financial markets was now so negative that such a step might not help weak euro zone states regain the ability to fund themselves.

"If that was to be a solution, it's a solution we should have implemented months ago, when it would have worked."

There has also been talk of expanding the 750 billion euro bailout facility which the EU and the IMF created last year as the debt crisis erupted. The EU source said there probably would not be enough time to agree on the idea this week.

The source familiar with the negotiations said that to reassure global markets, governments were considering proposals to make the EFSF more flexible by, for example, allowing it to recapitalize banks or provide precautionary credit lines.

Euro zone leaders may also issue a statement declaring Greece is a unique case, to try to convince private investors they will not be called on to help pay for bailouts of countries such as Ireland and Portugal. After recent credit rating downgrades, however, many investors are assuming the worst.

IMF

Another concern is that the IMF and other major governments around the world may lose patience with Europe.

German newspaper Die Welt quoted diplomatic sources as saying the IMF was angered by Europe's unsuccessful crisis management and that "influential parties" in the Fund wished not to take part in further bailouts of Greece. It did not elaborate.

U.S. Treasury Secretary Timothy Geithner said on Monday that Europe had to act more forcefully to contain risks in its banking sector, which is heavily exposed to Greek, Irish and Portuguese sovereign debt.

Former U.S. Treasury Secretary and White House adviser Lawrence Summers, writing in a column contributed to Reuters on Sunday, said Europe should move much more aggressively than it had done so far to prevent the Greek crisis from damaging both the region's single currency and the global economic recovery.

He recommended steps including sharp cuts in interest paid on bailout loans, allowing countries to buy European Union guarantees for their issues of new debt, and a menu of options for private investors to become involved.

"It is to be hoped that European officials can engineer a decisive change in direction but if not, the world can no longer afford the deference that the IMF and non-European G20 officials have shown toward European policymakers over the last 15 months," Summers wrote.

Many economists think some form of regional guarantee for countries' debt along the lines suggested by Summers -- or perhaps even the issuance of joint euro zone bonds -- may ultimately be the only way to emerge from the crisis without one or more weak states being forced out of the bloc.

But Germany has shown no appetite for such a solution, which in any case would require a complex revision of the EU treaty. Berlin is concerned that a common bond would provide no meaningful incentives for national governments to pursue prudent policies.

(Writing by Andrew Torchia; Editing by Ruth Pitchford)

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Europe considers Greek default, leaders to meet (Reuters)

BRUSSELS (Reuters) – European Union leaders are poised to hold an emergency summit after finance ministers acknowledged for the first time that some form of Greek default may be needed to cut Athens' debts and stop contagion to Italy and Spain.

"There will be an extra summit this Friday," a senior euro zone diplomat told Reuters, suggesting policymakers have been seized with a new sense of urgency after markets started targeting Italian assets.

A French government source said Paris was in favor, although the timing was not yet fixed, and in Spain, European Council President Herman Van Rompuy said he had not ruled out a meeting.

Earlier, Germany's finance minister had said a second Greek rescue package could wait until September after euro zone finance ministers effectively accepted that private creditor involvement meant a selective debt default was likely, despite the European Central Bank's vehement opposition to such a move.

"We have managed to break the knot, a very difficult knot," Dutch Finance Minister Jan Kees de Jager told reporters.

Asked about whether a selective default was now likely, he replied: "It is not excluded any more. Obviously the European Central Bank has stated in the statement that it did stick to its position, but the 17 (euro zone) ministers did not exclude it any more so we have more options, a broader scope."

Participants said a buy-back of Greek debt on the secondary market and a German proposal for a bond swap for longer maturities were under consideration after a complex French plan to roll over bonds made no headway.

Both would likely be regarded by ratings agencies as a default, or at best a selective default, which although it would not necessarily cover all Greek debt and could be lifted quickly, would have major repercussions for financial markets.

The Institute of International Finance, the lobby group representing private creditors, said the EU and IMF needed to deliver a plan for Greece, including a debt buyback, within days to avoid markets "spinning out of control.

The increased likelihood of some form of default, and a lukewarm response from the IMF, hit European bank stocks and debt markets and propelled the euro sharply lower against the dollar although markets settled later.

Ten-year bond yields in Italy, the euro zone's third-largest economy, shot above six percent for the first time since 1997 but then subsided to around 5.7 percent, still at a level which bankers say will put heavy pressure on finances.

Borrowing costs at an Italian 12-month bill sale surged to their highest since the 2008 financial crisis, putting a Thursday bond auction firmly in focus.

There is now acute concern about contagion to Italy, where political tensions between Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti have exacerbated concerns, and to Spain, the euro zone's fourth largest economy.

In Rome, Berlusconi tried to calm fears Italy could be swept into full-scale crisis, pledging to accelerate debt-cutting measures and run a primary surplus this year.

Willem Buiter, chief economist at Citi and a former UK central banker, said there was a clear spread beyond Greece, Ireland and Portugal, the three nations bailed out so far.

"We're talking a game changer here, a systemic crisis," he said. "This is existential for the euro area and the EU."

The euro fell to a four-month low against the dollar before recovering, in part because IMF Managing Director Christine Lagarde said the lender and its EU partners were not yet ready to discuss terms for a second Greek bailout.

"Nothing should be taken for granted," she told reporters in Washington.

FUNDAMENTAL SHIFT

While the finance ministers were not explicit about how they planned to tackle Greece's debt, saying only that proposals would be discussed "shortly," they acknowledged that the debt pile -- at around 160 percent of GDP -- had to be reduced.

"We stress the need to make Greek debt more sustainable," Jean-Claude Junker, the chairman of the Eurogroup of finance ministers, said after more than eight hours of talks on Monday.

Economists regarded Junker's words and the comments from other finance ministers as a fundamental shift.

"The euro area now seems to be moving more explicitly toward debt relief via EFSF-funded purchases of secondary market debt," JPMorgan economist David Mackie wrote in a research note, referring to the euro zone's 440 billion euro emergency loan fund, which as it stands would not have enough resources to bail out Italy.

"Greece will need debt relief at some point, but it is not clear it is much of a help now. More likely the shift toward debt relief is intended as an attempt to limit contagion."

The decision to call an extra leaders' summit helped counter negative market reaction to an apparent absence of hurry, after German Finance Minister Wolfgang Schaeuble said there was time to wait on Greece, with no new tranche due until September.

That lack of urgency prompted stern criticism from Greece's prime minister but the finance ministers did hint at the prospect of more fundamental steps to come.

"Ministers stand ready to adopt further measures that will improve the euro area's systemic capacity to resist contagion risk, including enhancing the flexibility and the scope of the EFSF, lengthening the maturities of the loans and lowering the interest rates, including through a collateral arrangement where appropriate," they said in a statement.

There was no indication, though, that they had broken a stalemate over how to make banks, insurers and other funds share the cost of additional funding for Athens.

A senior member of Germany's governing coalition acknowledged, however, that a debt restructuring was coming.

"We just need to ensure that it's as orderly a process as possible," he said, adding that it could come in the autumn.

Germany, the Netherlands, Finland and others want the private sector to provide at least 30 billion euros in a new package for Greece that could total 110 billion euros.

(Additional reporting by John O'Donnell, Leigh Thomas, Dan Flynn in Brussels, Silvia Westall in Vienna, Huw Jones in London, Stephen Brown in Berlin, Lesley Wroughton in Washington and Milan/Rome bureaus, editing by Mike Peacock)

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Rebels brace for attacks as Gaddafi threatens Europe (Reuters)

DAFNIYA/AL-QAWALISH, Libya (Reuters) – Rebel fighters braced for further attacks on Saturday from forces loyal to Muammar Gaddafi after the Libyan leader staged a show of support at home and threatened to strike his enemies abroad.

Rebels in Misrata said the death toll in the western town, a longtime insurgent stronghold, had risen to seven from six, with at least 17 wounded, after a heavy attack by Gaddafi artillery the day before.

A rebel spokesman in the town on the Mediterranean coast, who gave his name as Youssef, told Reuters: "The situation is calm today in Misrata. Yesterday seven rebels were killed. We expect fighting this evening."

Rebels have advanced on two fronts against Gaddafi forces in recent days, but government troops have fought back and Gaddafi has also sought to encourage his forces.

In a defiant speech late on Friday, Gaddafi threatened to export the war to Europe in revenge for the NATO-led military campaign against him, and to crush his enemies.

The "traitors" ranged against him in Libya and elsewhere will "fall under the feet" of the Libyan masses, he said.

In Tripoli and 800 km (500 miles) to the south in the desert town of Sabha, tens of thousands -- swelled by representatives of the tribes of the region -- gathered for Friday prayers in what appeared to be an attempt to show that Gaddafi enjoys widespread support in the areas he still controls despite the rebel gains of recent weeks.

Gaddafi supporters rallied in Tripoli's Green Square, underscoring his refusal to step down after four decades in power and five months of fighting.

Speaking on Libyan television, Gaddafi threatened to send hundreds of Libyans to carry out revenge attacks in Europe.

"Hundreds of Libyans will martyr in Europe. I told you it is eye for an eye and tooth for a tooth. But we will give them a chance to come to their senses," he said in an audio speech.

HEAVY FIRE

While the insurgents have advanced on two fronts, rebels in Misrata have come under heavy artillery fire from Gaddafi's forces.

A rebel sympathizer in Misrata told Reuters opposition forces had been moving closer to neighboring Zlitan, one of a chain of government-controlled towns blocking their advance to Tripoli.

As they advanced, pro-Gaddafi troops inside the city fired rounds of explosives to block their progress, the sympathizer said in an email.

"The rebels are waiting for NATO backup or for Gaddafi forces to run out of ammunition to make a move to take the city center," he said.

On the other major front, in the Western Mountains region southwest of Tripoli, NATO warplanes bombed forces loyal to Gaddafi several times on Friday, their bombs landing about 3 km (2 miles) east of the village of Al-Qawalish, according to one rebel fighter.

After weeks of static fighting, the rebels have made significant advances this week: pushing west from Misrata to within 13 km (8 miles) of Zlitan, where large numbers of pro-Gaddafi forces are based, and seizing the village of Al-Qawalish in the southwest.

Taking Al-Qawalish brings them closer to having control of a major highway into the capital.

Rebel advances over the last two weeks have allowed normal life to resume in towns no longer within shelling distance of Gaddafi's troops.

Rebels staged a military parade on Friday evening in Zintan, driving tanks through the streets of town in the Western Mountains. People fired rifles in the air including one small boy who opened fire with a Kalashnikov assault rifle while perched on his father's shoulders.

(Additional reporting by Lamine Chikhi in Sabha, Joseph Nasr in Berlin, Tarek Amara in Tunis; Writing by Giles Elgood)

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