EU crisis plan outlined, but pessimism remains

BERLIN - Germany suggested Wednesday that European leaders could fail to agree on a plan to tighten the continent's economic ties by the end of the week, dampening investors' optimism about a broad resolution of Europe's debt crisis.

Instead, a senior German official said it could take until Christmas for changes to the European Union treaty to be agreed upon, a critical first step in saving the euro.

It is unclear whether the leaders have that long, as ratings agencies have warned of a possible credit downgrade of 15 European countries unless they quickly build a firm plan to solve the continent's two-year-old debt crisis.

Markets turned lower after the German official's comments, dampening the optimism that had seen stocks and bonds rally over the past week. Investors had been hoping that a promise of more enforceable rules on budgets would permit the European Central Bank to take bolder action to reducing borrowing costs for Italy and other struggling countries.

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Germany's main stock index fell 1.1 percent, while the Dow futures were down 0.4 percent and the euro shed 0.3 percent to $1.3358.

The senior German official, speaking on condition of anonymity because talks were still ongoing, said his government will not consider an alternative to the proposal Chancellor Angela Merkel and French President Nicolas Sarkozy outlined Monday and published on Wednesday. That proposal calls for tightening budget controls, either through a change to the 27-nation EU treaty or by writing a new treaty for the 17 countries that use the euro.

But Herman Van Rompuy, the president of the European Council, says there's an easier way to get agreement on future fiscal discipline. He favors simply amending existing rules that apply to the 17 countries that use the euro. That would allow leaders to avoid the trickier step of requiring every country to approve the new treaty through parliamentary votes.

This split and others — including on whether to make automatic penalties for countries that overspend — has the potential to delay any agreement by European leaders, who had hoped to clinch one at the end of a summit in Brussels on Friday.

It could be Christmas before everyone agrees to a new treaty, the German official said. "If several rounds of negotiations are necessary for that then we are also prepared for that."

There are divisions between the 17 EU nations that use the euro and the 10 others that don't over how to handle treaty changes.

The 10 EU countries that do not use the euro are concerned that they'll be left out of future economic discussions that would affect all of Europe, although Germany has insisted that any interested countries would be welcome to adopt the changes of the eurozone 17.

British leader David Cameron is wary of losing power with the 27-nation bloc if France and Germany create a tighter club of eurozone nations with tough rules for national budgets. And his government does not want to transfer any of its decision-making powers to Brussels.

Markets have nevertheless rallied over the past few days on the hope that at least a tentative deal will be secured this weekend. Stocks and bonds have risen, while the borrowing rates for key countries like Italy and Spain fell to monthly lows.

Experts say those gains are based largely on hopes that the European Central Bank will eventually step up its support for weak eurozone countries.

ECB President Mario Draghi hinted in a speech last week that a commitment by euro countries to crack down on overspending could set the stage for further financial assistance from the bank.

Markets have interpreted Draghi's comments to mean that the ECB could get more aggressive in purchasing European government bonds. Those bond purchases would likely drive down interest rates, allowing debt-laden countries to cut their borrowing costs.

Earlier Wednesday, U.S. Treasury Secretary Timothy Geithner struck a more optimistic tone on the prospects for a deal.

"We are very encouraged with the progress that is being made," Geithner said to reporters following a meeting with French Finance Minister Francois Baroin on the second day of his whirlwind trip through Europe.

The proposals agreed on by the German and French leaders are based on three key issues to be debated in Brussels:

• Having all 17 countries that use the euro amend their constitutions to require balanced budgets.
• Instituting enforceable penalties for countries that run excessive budget deficits using EU institutions such as the European Commission and European Court of Justice. The use of those institutions might require that all 27 EU countries agree to it.
• Trying — again — to greatly increase the EU's financial capacity to bail out countries in trouble. The hope is that markets will not worry so much about what will happen if one of the euro-using countries goes bust.

It is still a matter of debate whether some of these changes, such as the penalties, should be brought into force by amending the EU's governing treaties, or by creating a new treaty among those countries that use the euro.

There are arguments on both sides. Creating a new treaty for the euro countries would be faster than amending the EU-wide treaty, which might require parliamentary ratification in 27 countries, and perhaps nationwide referendums in some of them.