European leaders agree on long-term union

From right, European Commission President Jose Manuel Barroso, European Council President Herman Van Rompuy and Denmark's Prime Minister Helle Thorning-Schmidt participate in a media conference at an EU Summit in Brussels on Thursday, June 28, 2012. European leaders gathering Thursday in Brussels are set to sign off on a series of measures to boost economic growth but expectations of a breakthrough on the pooling of debt have fallen by the wayside. AP Photo/Virginia Mayo

Updated 11:10 PM ET

(CBS/AP) BRUSSELS - European leaders have agreed to use the continent's permanent bailout fund to recapitalize struggling banks, and agreed to the idea of a tighter union in the long term.

The bank decision at overnight meetings in Brussels on Friday was aimed at helping Spain, which sought a euro100 billion rescue to help its troubled banks and is facing rising borrowing costs.

EU President Herman Van Rompuy called it a "breakthrough that banks can be recapitalized directly."

He said leaders of the 17-nation eurozone also agreed to a joint banking supervisory body.

He said the leaders of the full 27-member European Union agreed to a general long-term plan for a tighter budgetary and political union.

Earlier, the leaders scrambled early Friday to consider emergency measures to lower the borrowing costs of Italy and Spain. The success of a summit meant to reassure markets hung in the balance.

A modest agreement by the 27 leaders of the European Union to spend euro120 billion ($149 billion) to stimulate economic growth was thrown into flux after Italy and Spain said they would block it unless it was paired with immediate action to help lower the interest rates on their government bonds.

"We see it as a package," said an Italian official, though only on condition of anonymity because the closed-door talks are ongoing.

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In a further setback to European leaders' hopes of projecting progress, discussions on longer-term fixes to the continent's financial crisis were postponed until October, French President Francois Hollande said. Some proposals on the table include: centralized banking regulation, Europe-wide deposit insurance and handing the EU more authority over individual countries' taxing and spending plans.

Experts say the $149 billion in stimulus spending the leaders agreed to is too small to have much of an impact in an economic region as large as Europe.

"They underperformed my low expectations," said Megan Greene, Director of European economies at Roubini Global Economics. She said the stimulus package "won't create growth."

More important to many observers is finding immediate ways to address the high borrowing costs currently faced by Italy and Spain. Economists say Spain can only pay the current high rates — at 7 percent for 10-year money- for a few more months. After that, it is likely to ask for a eurozone bailout to finance its government debts. That rescue money could range in the hundreds of billions of euros (dollars).

To lower those borrowing rates, European leaders need to convince investors that Spain and Italy will be able to keep repaying their debts.

Sharp divisions remain over such measures to boost market confidence, however. They range from allowing the eurozone bailout fund to buy the bonds of the governments of Italy and Spain to bolder, longer-term moves like pooling government debt.

The leaders of Italy, France and Spain have been pressing Germany to agree to some form of these confidence-boosting measures. The EU's top officials and the International Monetary Fund have argued the same.

German Chancellor Angela Merkel has so far opposed such measures.

She says eurobonds should be part of Europe's effort to integrate, but can only happen once national governments have agreed to give a central authority the power to change their budget policies. That could take years — and now the start of that process has been postponed in the wake of Thursday's impasse.

As the biggest economy among the 17 countries that use the euro, Germany would have to shoulder the brunt of the debt. Merkel is also concerned eurobonds would ease the pressure on financially weaker countries to reform their economies. That includes making labor markets more flexible, lowering business costs, cutting red tape and fighting tax evasion. Spain also needs to force its banks to cover massive losses from an imploded real estate markets.

While pressure on Merkel has been building, she is not alone in her opposition to eurobonds. Austria, Finland and the Netherlands are also opposed, among euro countries.

Without any emergency measures to reassure investors over the fate of Spain and Italy, the growth pact is likely to leave markets disappointed.

European Council President Herman Van Rompuy said the lending capacity of the European Investment Bank would be increased by euro60 billion, adding that "this money must flow across Europe, and at least to the most vulnerable countries" to help them grow out of the crisis.

But that includes euro50 billion in already existing EIB money, with only euro10 billion in new capital, as it loans alongside private investors. The EIB's board has cautioned that it may have difficulty in finding projects that meet its standards.

Then there are euro55 billion in funds that were already earmarked in the EU's 2013 budget for growth projects in poorer regions around Europe.

Finally, the pact will make another euro5 billion in "project bonds" available to invest in transport, sustainable energy and digital infrastructure. While the EU budget will provide some risk cushion for the EIB to finance the underlying projects, the EIB would have to cover the remaining risk.

"It's not just about injecting money. Growth is an overriding concern in every aspect of our work," Van Rompuy said.

Prime Minister Helle Thorning-Schmidt of Denmark, which holds the rotating presidency of the EU, said the growth and jobs compact would be formally adopted Friday, calling it "a light in the dark" for Europeans.

The funds for growth measures are a "very, very small step," said Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington, D.C.

"That's more of a political fig leaf for Francois Hollande," Kirkegaard said. France's Socialist President Francois Hollande won election last month campaigning against austerity measures by his conservative predecessor and saying governments need to invest in stimulus instead.

Five euro countries have so far asked for financial aid from their partners in the currency union. Greece, Ireland and Portugal have taken rescue loans to finance their government debt. Spain has asked for as much as euro100 billion for its banks. Cyprus has asked for aid for its banks, as well.

Italy's Prime Minister Mario Monti, at risk of losing his job because of voter frustration with budget cutbacks, said Italians have made great sacrifices and gotten their country's deficit under control but the yields on Italian debt have soared to anyway. Italy's deficit was 3.9 percent of GDP as of the end of 2011, far lower than Spain's 8.5 percent. But its 10-year yield was above 6 percent.

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