Eurozone gets ECB boost, summit deal uncertain (Reuters)

BRUSSELS/ROME (Reuters) – The incoming head of the European Central Bank threw the euro zone a lifeline hours before a crucial summit on Wednesday which looked set to fall short of a definitive plan to tackle the bloc's debt crisis.

Mario Draghi signaled the ECB would go on buying troubled states' bonds as leaders of the 17-nation single currency area struggled to agree a convincing set of measures.

"The Eurosystem (of central banks) is determined, with its non-conventional measures, to prevent malfunctioning in the money and financial markets creating an obstacle to monetary transmission," he said in typically coded ECB language in a speech text released in Rome.

Draghi, who will succeed Jean-Claude Trichet on November 1, made clear that measures could only be a temporary expedient and said it was up to governments to tackle the roots of the debt crisis that began in Greece two years ago.

However, his statement appeared to rebuff pressure from Germany's powerful Bundesbank for the ECB to end the bond-buying program which prompted the resignation of the two most senior German ECB policymakers this year.

The second euro zone summit in four days, due to start at 1730 GMT, seems unlikely to produce a detailed masterplan despite Franco-German assurances that a "comprehensive solution" to two years of debt turmoil would be found.

Bank of Canada chief Mark Carney said he had received guidance that "that there will need to be subsequent meetings to provide more detail."

Dutch Prime Minister Mark Rutte urged decisive action now.

"We need a real solution, we won't buy anything with mediocre compromises," he told reporters upon his arrival in Brussels. "We are in this job to take decisions. It's not easy, but it really has to happen."

Greek debt needed to be made sustainable, the bloc's rescue fund must be made strong enough to convince markets and Europe's banks had to be shepherded through "this difficult phase," Rutte said.

The leaders may agree on broad outlines but leave crucial details, including the numbers on a Greek debt write-down and on funds available for financial fire-fighting, for later negotiation among finance ministers.

A European Commission spokesman said there would not be detailed numbers on all aspects of the political agreement.

While there is consensus on the need for European banks to raise around 110 billion euros ($150 billion) in extra capital to withstand a potential Greek debt default and wider financial contagion, two other critical parts of the plan remain unclear.

Governments and banks are still haggling over the scale of write-offs private bondholders will have to take on their Greek debt holdings, sources familiar with the negotiations said.

"There will be give and take with the banks until the last minute," a Greek government source involved in the Brussels negotiations said. "As far as now, the talks are going on."

Uncertainties also remain around complex plans to scale up the region's 440 billion euro ($600 billion) bailout fund, known as the European Financial Stability Facility, without allowing it to draw on the ECB.

Investors stayed cautious, with the euro surrendering earlier gains and inching higher against the dollar and European shares flat on the day.

50 PERCENT "HAIRCUT?"

One proposal set to be adopted involves creating a special purpose investment vehicle (SPIV) to tap foreign sovereign and private investors, such as Chinese and Middle Eastern wealth funds, to buy bonds of troubled euro zone countries.

The EFSF said its chief, Klaus Regling, would visit China to meet with investors on Friday.

But Chinese and European officials said there was no word yet on whether Beijing, which holds AAA-rated EFSF bonds and an estimated 600 billion euros in euro-denominated debt, would also put money into the SPIV.

The other proposed method for scaling up the EFSF involves using it to offer partial guarantees to purchasers of new euro zone debt. The two options may be used in combination.

German Chancellor Angela Merkel won a parliamentary vote of support for strengthening the rescue fund after warning in a dramatic speech that Europe was facing its most difficult situation since the end of World War Two.

"If the euro fails, then Europe fails," she declared, saying there was no certainty that the continent would then enjoy another 60 years of peace.

Merkel earlier told parliament that private bondholders would have to take a substantial write-down so that Greece's debt could be reduced to 120 percent of gross domestic product by 2020 from 160 percent this year.

Experts say that implies a 50 percent "haircut" for private investors, which Greek Finance Minister Evangelos Venizelos was reported to have told Greek banks was the most likely outcome.

Jean-Claude Juncker, the chairman of euro zone finance ministers, forecast an eventual deal on a 50 percent write-off but officials said it might not be sealed on Wednesday and the banks wanted a menu of options for the bond swap rather than a single solution.

European leaders' pattern of responding too little, too late has spawned a wider economic and political crisis that threatens to undermine the euro single currency and the European Union project.

EU sources said detailed figures may not materialize until November 7-8, when EU and euro zone finance ministers hold their next regular meeting.

LETTER OF INTENT

Also weighing on the summit was deep concern about Italy, which is now in the bond market firing line.

Rome's inability to deliver a substantive plan for reforming its pensions system has raised doubts about Prime Minister Silvio Berlusconi's seriousness in tackling a crisis that threatens the euro zone's third largest economy.

Berlusconi was bringing to Brussels a "letter of intent" to his European partners on long awaited reforms, aides said, after his government nearly collapsed on Tuesday over their demands that Rome fulfill a pledge to raise the retirement age.

The letter was expected to contain only vague promises of economic reform rather than the firm undertakings sought by exasperated EU leaders in return for support for Italy's bonds.

Italy has the euro zone's largest sovereign bond market, with a public debt of 1.8 trillion euros, 120 percent of GDP. If it went the same way as Greece, Ireland and Portugal, the rescue fund does not have enough money to bail Rome out.

Draghi's statement appeared to supersede a dispute between Germany and France over how the ECB, the ultimate defender of the euro, should be involved in trying to resolve the crisis.

Paris had wanted the summit to endorse a continuation of the ECB's "non-standard measures" as long as Europe faces exceptional circumstances.

Merkel said Germany opposed a line in the draft summit conclusions urging the ECB to continue these measures. A euro zone source said the phrase would be dropped.

(Additional reporting by Annika Breidthardt and Sarah Marsh in Berlin, Daniel Flynn and Harry Papachristou in Athens, Barry Moody in Rome; Writing by Luke Baker and Mike Peacock; editing by Janet McBride)

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Germany, France split on bank aid before summit (Reuters)

BERLIN/PARIS (Reuters) – Germany and France were split ahead of crucial talks on Sunday over how to strengthen shaky European banks and fight financial market contagion to prepare for a possible Greek default.

Under strong U.S. and market pressure Chancellor Angela Merkel and President Nicolas Sarkozy will try to bridge differences on how to use the euro zone's financial firepower to counter a sovereign debt crisis that threatens the global economic recovery.

A ratings downgrade on both Italy and Spain by Fitch Ratings on Friday underscored the grim climate.

A German source said Paris wanted to be able to tap the euro zone's 440 billion euro rescue fund to recapitalize its own banks, which have the largest exposure to peripheral euro zone debt, while Berlin insisted the fund should be used only as a last resort when no national funds are available.

After meeting Dutch premier Mark Rutte, Merkel confirmed the German position was that the European Financial Stability Facility was a backstop to be used "only if that country is unable to cope on its own.

A French Treasury source told Reuters that Paris believed banks unable to raise capital on the open market should be able to tap the fund, but talk of divergences with Berlin was premature since the issue had not yet been debated.

Merkel said struggling banks should look first to the markets, then their national government, and only in the last instance the EFSF, and with reforms as a strict condition.

"This will definitely be discussed at the next summit," she said, referring to an EU leaders meeting on October 17 and 18 for which she and Sarkozy will attempt to set the agenda.

The French government and the Bank of France had dismissed until this week any need to recapitalize French banks and are now wrangling over how to do it in a way that does not put the country's top-notch credit rating at risk.

"I hear that the French are scared that too much bank recapitalization could jeopardize the French AAA and that is why they push for the EFSF solution for French banks. I expect Merkel to stick to national funds for recapitalization," said economist Jacques Delpla, a member of the French government's advisory council of economic analysis.

France has the highest debt-to-GDP ratio of any of the six triple-A countries in the euro zone at 86.2 percent.

If France, the second largest guarantor of the rescue fund after Germany, were to lose its top-notch rating, the whole edifice of financial support for Greece, Portugal and Ireland would crumble.

DEXIA SQUABBLE

A senior European diplomat said that because of its exposure and concern for its credit rating, France was more hesitant than Germany or Britain about the need to restructure Greece's debts and take losses as soon as possible.

Preserving France's AAA status was politically sensitive seven months before a presidential election in which Sarkozy is trailing the opposition Socialists in opinion polls, he said.

Many major European banks continue to insist they need no more capital, although the International Monetary Fund says up to 200 billion euros must be injected.

The chief executive of Societe Generale , Frederic Oudea, told Reuters Insider TV the main problem was not one of capital but liquidity as interbank lending dries up.

"The main issue is a crisis of confidence in the sovereign. ... What is important is to deal with the Greek issue as quickly as possible and then rebuild confidence in the capacity of each bank in Europe to reduce its debt," Oudea said at SocGen's Paris headquarters.

Some banks are clearly in need, however.

France and Belgium are arguing over whose taxpayers should pay to salvage cross-border municipal lender Dexia, which came close to collapse this week and is to be broken up.

Moody's Investor Service on Friday said it may cut Belgium's credit rating.

U.S. President Barack Obama implored European leaders on Thursday to come up with a plan before a Group of 20 major economies summit in Cannes, France, on November 3-4, saying the euro zone crisis was the biggest cloud over the U.S. economy.

Bank of Japan Governor Masaaki Shirakawa said on Friday that the European sovereign debt woes were putting Japan's economy under growing strain.

Shirakawa told a news conference in Tokyo that "global growth is slowing as a trend" and European growth was "stalling" as debt worries mount.

European Commission President Jose Manuel Barroso said on Thursday the EU's executive arm was preparing a plan for bank recapitalization across the 27-nation bloc.

However, other EU officials have made clear it would only be a set of guidelines for national measures and an approach for cross-border banks, and not a common European mechanism or mandatory rules on recapitalization.

The European Banking Authority, which coordinates national regulators, is reassessing banks' capital buffers based on data provided for stress tests conducted in July, which showed that only eight banks failed, requiring just 2.5 billion euros in extra capital.

A euro zone supervisory source said a figure of 180-200 billion euros cited by International Monetary Fund and private economists reflected the impact of writing down sovereign bond holdings to current low market prices and assuming that Greece and perhaps another country would default.

DEFAULT POSSIBLE?

Both Merkel and Sarkozy have reaffirmed in the last week that a Greek default must be avoided because it would have potentially catastrophic consequences for the European and global economy.

The French Treasury source said Paris was open to modifying some elements of a July 21 agreement by euro zone leaders to make private bondholders share the cost of a second bailout for Greece, such as debt maturities and interest rates, but a full-scale rewrite was undesirable.

German and Finnish officials argue that since market conditions have changed, banks may need to take more than the agreed 21 percent write-down on their Greek holdings.

A team of EU and IMF inspectors is continuing negotiations with Greece on reforms required to release a vital 8 billion euro aid installment by mid-November.

Fitch late Friday cut Italy's sovereign credit rating by one notch and Spain's by two, citing a worsening of the euro zone debt crisis and a risk of fiscal slippage in both states.

The downgrades knocked the wind out of the euro, which slipped 0.3 percent to $1.3388, leaving it rooted in a downtrend that began at $1.4548 on August 29.

Italy's rating fell to A-plus from AA-minus, and Spain's was lowered to AA-minus from AA-plus. Both countries, respectively the third and fourth largest economies in the euro zone, were placed on a negative outlook suggesting further downgrades could come in future.

(Additional reporting by Jean-Baptiste Vey and Catherine Bremer in Paris, Paul Carrel in Berlin, Philipp Halstrick in Frankfurt, Julien Toyer in Brussels,; Writing by Paul Taylor/Mike Peacock/Glenn Somerville)

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China, U.S. play down tensions at Asian security summit (Reuters)

NUSA DUA, Indonesia (Reuters) – The United States and China moved to repair strained ties on Friday, saying tensions over the South China Sea were easing with new conduct guidelines between Beijing and Southeast Asian nations.

Secretary of State Hillary Clinton and Chinese Foreign Minister Yang Jiechi, meeting at Asia's biggest security conference, appeared eager to ensure the dispute over the oil and gas-rich waters did not become another source of friction between the world's largest economy and the second-largest.

"I want to commend China and ASEAN for working so closely together to include implementation guidelines for the declaration of conduct in the South China Sea," Clinton said at the meeting on the Indonesian resort island of Bali.

Clinton will outline the U.S. position in more detail in an address on Saturday, saying Beijing and its Southeast Asian neighbors need to do more to cut tensions, boost communication and work out legal and operational details of their new deal.

But U.S. officials said China was clearly ready to tamp down tensions over the issue.

"China has come to this meeting with a clear determination that they want to ease anxieties," one senior U.S. official told reporters.

China acquiesced to the new guidelines on Thursday after almost a decade of deadlock, in what may have been an attempt to mollify ASEAN enough to take the topic off the table before Clinton's arrival. China, Taiwan, and four ASEAN members -- the Philippines, Malaysia, Brunei and Vietnam -- all claim territory in the South China Sea and Washington has irritated Beijing by declaring it also has a national interest at stake in ensuring freedom of navigation and trade.

China says it has had undisputable sovereignty over the South China Sea since ancient times, and is adamant about not involving other parties to help resolve the matter.

The U.S. official said Clinton's speech on Saturday would address some of these concerns, and advocate for a more straightforward legal process to resolve disputes.

China has accused the United States of triggering tension in the region by holding naval drills, and President Barack Obama's meeting with Tibetan spiritual leader the Dalai Lama last week has added further strains.

Foreign minister Yang, hosting Clinton for bilateral talks on the sidelines of the ASEAN security forum, said the South China Sea guidelines would "go a long way to maintaining peace and stability and good neighborliness in the region."

Diplomats said the guidelines were only a small, but important, step toward resolving one of the region's longest-standing disputes.

"If parties concerned abide by the guidelines, certainly tensions will be reduced," said a senior Asian diplomat.

"We have to engage with China so China takes the right course. China has to understand international rules and the South China Sea dispute is an important test case."

UNDERSTANDING SENSITIVITIES

Yang did not mention Obama's meeting with the Dalai Lama, regarded by Beijing as a violent separatist, but a Chinese spokesman indicated it could come up.

"We believe that it is important to respect the sovereignty and territorial integrity of China, and to respect China's major concerns on the issue of Tibet and some other sensitive issues," spokesman Liu Weimin told reporters.

"I sense the U.S. side understands the sensitivity of these issues and we both agreed to promote further dialogue."

The U.S. official said China was "solemn" in its discussion of the Dalai Lama issue, but held its fire.

"I've been in meetings before where some of the rhetoric can be carried away. It was polite and respectful from both sides," the official said, taking this as a signal from Beijing "to maintain forward momentum" in the relationship.

Yang focused on U.S.-Chinese cooperation on a range of issues including efforts to bring North Korea back into six-party negotiations on its nuclear program.

U.S. officials said Clinton's meeting in Bali with Yang marked the start of several months of high-profile diplomacy in the region that both sides want to succeed.

Both Obama and Chinese President Hu Jintao are due to attend a meeting of the APEC Asia economic forum in Honolulu later this year, and Obama will also attend November's East Asia Summit in Bali for the first time, giving him another chance to touch base with the Chinese leader.

Clinton will fly on Sunday from Bali to Hong Kong -- the first U.S. secretary of state to visit since 1997 when China resumed control of the city from Britain -- and will stop by the southern Chinese city of Shenzhen on Monday for a meeting with Chinese State Councilor Dai Bingguo.

Clinton is due to give a speech in Hong Kong on Monday that will emphasize the U.S. view of economic ties with China, which have been a serious source of tension in the past. (Additional reporting by Raju Gopalakrishnan; Editing by Raju Gopalakrishnan and Sugita Katyal)

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EU warns of economic damage if Greece summit fails (Reuters)

BRUSSELS/FRANKFURT (Reuters) – EU leaders must find a convincing solution to Greece's debt crisis at a summit on Thursday or the global economy will pay the price, the head of the European Commission said in an unusually somber warning.

Jose Manuel Barroso delivered the message as officials of the 17-nation currency area and bankers struggled to pin down a package of measures to persuade markets Greece can be saved from default and the rest of the euro zone from contagion.

"Nobody should be under any illusion: the situation is very serious. It requires a response, otherwise the negative consequences will be felt in all corners of Europe and beyond," Barroso told a news conference.

He said the elements of a solution must include: measures to ensure the sustainability of Greek public finances, private sector involvement in funding for Athens, more flexible use of the euro zone's EFSF bailout fund, repair of the region's banking system and liquidity to keep the economy going.

In what sounded like veiled criticism of German Chancellor Angela Merkel, Europe's reluctant paymaster, Barroso said it was time for leaders to say "what they can do and what they want to do. Not what they can't do and won't do."

Merkel lowered expectations on Tuesday, saying the summit would not bring a spectacular one-shot solution to the Greek crisis but only the latest in a series of incremental steps to tackle the roots of Athens' debt and competitiveness problems.

Christine Lagarde will attend the summit on behalf of the International Monetary Fund, which has told euro zone leaders that they should put more money into the EFSF bailout fund and allow it to buy government bonds on the secondary market.

The euro and peripheral euro zone bonds rose on hopes that policymakers would heed the IMF's advice on bond purchases and provide precautionary credit lines to countries in difficulty.

BANKS' PROPOSAL

However, Germany has so far blocked either course, and while a source close to the talks told Reuters earlier this week that both ideas were back on the table, there is no sign yet that Berlin has changed its mind.

Both would require changes in the EFSF's rules that would have to be ratified by national parliaments, and could fall foul of skeptics in Germany, the Netherlands and Finland.

They would also run counter to a treaty signed just three weeks ago creating a permanent crisis-resolution mechanism from 2013, the ESM, which would not have such powers.

Major European banks and insurers were to send euro zone governments a complex proposal later on Wednesday for helping in a planned 115 billion euro second Greek bailout, industry sources said.

One banking source said the banks were offering a mixture of debt rollovers, maturity extensions and other measures worth roughly 40 billion euros over three years, but details have yet to be finalized.

Another source said negotiations were still fluid but key elements would be a large rollover of expiring bonds for up to 30 years on credit-enhanced terms, and probably a much smaller buyback by the Greek government of its own bonds on the secondary market with money lent by the EFSF.

Those options would almost certainly prompt credit ratings agencies to declare a selective default, putting the European Central Bank in an acute dilemma as to whether to carry out a threat to reject Greek bonds as collateral -- a move that would starve Greek banks of vital liquidity.

The banks are determined to fight a proposal for a tax on the financial sector to help pay for a second Greek rescue, which a euro zone working paper obtained by Reuters on Tuesday showed was seen as the least risky private sector contribution.

A senior EU source said governments seemed to be converging around the tax proposal despite its drawbacks.

"We're heading for another sticking plaster deal," he said. "We're in a crisis and there's panic. Sometimes panic can lead to action, but it can also lead to paralysis, and in this case it's more about paralysis."

Banking sources said a tax would unfairly penalize banks with no exposure to Greek debt and would inevitably give rise to legal challenges.

"GERMAN RETICENCE"

Merkel and French President Nicolas Sarkozy, who conferred by telephone on Tuesday, met in Berlin on Wednesday evening for what could be the decisive preparatory session before euro zone officials start thrashing out details on Thursday morning, just hours before the summit, which could run late into the night.

There were no plans for Merkel and Sarkozy to talk to reporters, officials said.

"We are very confident that there will be a good and sensible solution," Merkel's spokesman said, stressing private sector participation remained a key German priority.

French Foreign Minister Alain Juppe also said he was "sure we will find an accord," adding that contrary to media reports, "there is a very broad convergence of views" among euro zone capitals.

However, Paris signaled apparent frustration at Berlin's continued opposition to common euro zone bonds, a step which European Socialist leaders and many economists argue would provide a long-term solution to the debt crisis.

French government spokeswoman Valerie Pecresse said after a cabinet meeting that "German reticence" was the main obstacle to the idea of issuing joint euro bonds.

Despite Wednesday's cautious market optimism, many analysts fear the fifth European summit this year will produce half-measures that, at most, will buy a couple of months before pressure for a Greek debt restructuring becomes acute again.

"(The) summit could provide the last chance for euro-zone policymakers to get a grip on the region's debt crisis," Capital Economics said in its daily market note.

"Anything other than a very decisive response could see the situation become irretrievable."

The ECB kept up a drumbeat of pressure on euro zone leaders to avoid any step that could cause a selective Greek default.

ECB chief economist Juergen Stark said in a newspaper he hoped the leaders would stick to a previous commitment to avoid a selective default, because anything else would confuse markets.

(Additional reporting by Alex Chambers, Jessica Mortimer and Kirsten Donovan in London, Andreas Rinke and Stephen Brown in Berlin, Nick Vinocur in Paris; writing by Paul Taylor; editing by Janet McBride)

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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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Germany digs in heels over Friday summit on Greece (Reuters)

BRUSSELS/BERLIN (Reuters) – Euro zone plans for a leaders' summit on a second Greek rescue were thrown into doubt by Germany on Wednesday, raising fears markets may exploit a policy vacuum with a new onslaught on the bloc's high debtors.

Berlin stuck to its line that Greece was funded until September so there was no rush to finalize the details of a second package. "There are no concrete plans for a special summit," a German government spokeswoman said.

Others were less sanguine. Italian central bank chief Mario Draghi, soon to take the helm of the European Central Bank, and Ireland's premier both said a definitive plan was needed and quickly -- echoing a strongly-worded attack from Greece's prime minister earlier in the week.

Ratings agency Moody's downgraded Ireland's credit to junk status on Tuesday and said that, like Greece, it would need a second bailout. Minds have been focused even more sharply by a market attack on Italy which, if it required assistance, would overwhelm the euro zone's existing rescue funds.

"Moody's problem is not with Ireland, Ireland's problem is with Europe," Prime Minister Enda Kenny told parliament. "There is no point in having a meeting that won't bring about a conclusion in a comprehensive sense to something that is not going to go away unless it is dealt with."

The European Commission, sharply critical of the role ratings agencies are playing, described Moody's decision as "incomprehensible." The cost of insuring Irish debt against default rose and 10-year bond yields hit 14.19 percent.

Italian and Spanish bonds settled but traders did not expect long-term respite without decisive action.

"We are still pretty bearish on the periphery in general given there are various risk factors in terms of the policymakers' response to the crisis so far," said Michael Leister, a strategist at WestLB. "We're not too convinced they can turn things around in the short term."

WRANGLING

The leaders need to pin down how private holders of Greek government bonds can be persuaded to shoulder a portion of the cost of a new package for Greece, and weigh up the potential impact on markets if securing their involvement is declared a debt default by ratings agencies, as expected.

But they appeared to be subsiding into a bout of internal wrangling and risk creating a no-win situation:

If no summit is now held on Friday, it could have a strong negative impact on financial markets. If it is held and no clear decision is taken, the impact could be worse.

Herman Van Rompuy, the president of the European Council, has informed ambassadors he intends to hold the summit on Friday evening, and most of the 17 euro zone member states back that decision, but Germany is reluctant to fix the date, especially if there is no decision ready to take.

"Markets reacted very badly after euro zone finance ministers could not reach an agreement," an EU diplomat said, referring to a finance ministers' meeting on Monday. "If they cannot agree, we take the fight to the highest level. People are working on a set of conclusions to be agreed."

A senior EU official said the Germans were furious about being "backed into a corner" and were therefore holding firm on not attending on Friday, which would skittle the summit. Diplomats said furious rounds of phone calls were being made.

They said the current intention was for leaders to meet on Friday evening and for finance ministers to gather again on Sunday so the precise details of a plan can be fixed before financial markets open on Monday.

STRESS TESTS

A major concern on leaders' minds will be the results of stress tests on 91 European banks, to be released on July 15, which are expected to show 10 or more banks may have failed.

That could have a further impact on Italy, where bank stocks and the bond market have been hit by growing concerns that the euro zone's third-largest economy could be next in line after Greece, Ireland and Portugal to suffer debt contagion.

Draghi said Italian banks would comfortably pass the stress tests but echoed Kenny's call for a comprehensive EU response to the spreading debt crisis.

"We have to recognize that management of the financial crisis has not gone smoothly with partial and temporary interventions," he said in a speech to the Italian banking association.

"We must now bring certainty to the process by which sovereign debt crises are managed, by clearly defining political objectives, the design of instruments and the amount of resources," he said.

Current proposals on the table for securing the private sector's involvement in Greece focus on the buy-back of Greek government bonds and the swapping of existing Greek debt for longer-dated securities with a lower coupon, which would materially reduce Athens' outstanding obligations.

However, it remains unclear how a buy-back of Greek bonds would be financed. One proposal is to use the 440 billion euro European Financial Stability Facility (EFSF), which has been used to bail out Ireland and Portugal.

The ECB remains vehemently opposed to any Greek plan that ratings agencies would be likely to see as a default.

ECB policymaker Jens Weidmann, a former adviser to German Chancellor Angela Merkel, said the EFSF should not be used to buy bonds in the secondary market and it would be unacceptable for the ECB to accept defaulted Greek debt as collateral.

"The money of the (EFSF) bailout should not be used for the purchase of government bonds in the secondary market," he told Die Zeit newspaper. "Containment of the crisis should not mean that we undermine our principles. We must draw a red line."

But Germany's finance ministry said funds from the euro zone's rescue mechanism could in theory already be used by members of the bloc to buy back their own bonds, suggesting a shift in Berlin's stance.

German newspapers ran headlines and editorials on Wednesday calling on leaders to get their act together.

"The fact that some important heads of state have still not realized the entire amplitude of the problem is ... disastrous," a commentator wrote in Die Welt.

One Eurogroup official said Friday's meeting, if it happens, may not deliver on what the market is expecting.

"If there is a meeting on Friday, it is more psychological support than anything else. The heads of state will not decide anything," he said, explaining that there was not enough time between now and then to prepare a meaningful decision.

(Additional reporting by Julien Toyer and Luke Baker in Brussels, and by Noah Barkin and Gernot Heller in Berlin; editing/writing by Mike Peacock)

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