HOPES for a grand plan to solve the European debt crisis were fading ahead of last night's emergency summit in Brussels, with France and Germany still at odds over the rescue package and Italy's coalition government facing potential collapse over differences on austerity.
Fears of a double-dip global recession rose as a meeting of the European Union's 27 finance ministers that had been planned for the start of the summit was cancelled.
The leaders of the EU countries were still set to meet overnight to discuss rescue proposals non-euro countries such as Britain are keen to ensure they are not disadvantaged by any deal and then the 17 members of the single-currency euro zone were to meet to vote on final measures.
The prolonged political hand-wringing over the 18-month debt crisis produced near despair among some EU diplomats. One official told The Guardian: "Everybody realises that we are on the brink of such a total catastrophe that anything that prevents it and a huge recession must be grasped. The markets will kill us if they haven't laughed themselves to death."
The rescue proposals have three pillars: persuading creditors to give up hope of being repaid a large proportion of Greek debt (known as a write-down or a "haircut") injecting more money into Europe's banks so they can withstand the shock waves of a Greek default and boosting the euro zone's bailout fund, the European Financial Stability Facility, so that it can cope if larger debt-ridden economies such as Spain or Italy need to call upon it.
There seems to be agreement that banks should get ?108 billion ($A144 billion) to increase their capital base so they will not have to freeze lending if they lose large amounts of money over Greece.
But the other two strands of the deal are facing hurdles. Private creditors are reportedly resisting pressure by the European Commission and the European Central Bank to accept haircuts of up to 60 per cent, three times the 21 per cent agreed to in July. Banks have offered 40 per cent and warned that anything more would endanger the banking system.
The size of the debt write-down must be decided before the final figure of the boost to the bailout fund, which could go as high as ?2 trillion, can be calculated.
Meanwhile, German Chancellor Angela Merkel and French President Nicolas Sarkozy are again at loggerheads over whether the European Central Bank should buy up more Spanish and Italian bonds to support those countries. Dr Merkel rejected a draft summit communique that appeared to suggest this measure should continue.
Dr Merkel faces strong domestic opposition to the ECB's bond-buying. Germans fear it will lead to inflation and compromise the central bank's independence.
The two leaders are united, however, in their insistence that Italian Prime Minister Silvio Berlusconi arrive at the summit with his divided coalition pulled into line behind a plan to slash Italy's ?1.9 trillion debt.
On Tuesday, negotiations with Mr Berlusconi's Northern League coalition partner over pension reform and an increase to the retirement age had broken down so badly that it was thought Italy might face an election over the issue.
Northern League leader Umberto Bossi said he was "pessimistic" about the government's survival.
Frequently Asked Questions about this Article…
What is the key deal being discussed to resolve the Eurozone debt crisis?
The emergency summit was debating a three-pillar rescue plan: persuading private creditors to accept a write-down (a "haircut") on Greek debt, injecting capital into European banks so they can continue lending, and boosting the euro zone's bailout fund (the European Financial Stability Facility) so it can handle larger bailouts for countries like Spain or Italy.
What does a "haircut" on Greek debt mean and how big could it be?
A haircut is a write-down that asks creditors to accept getting back less than they're owed. The summit discussed haircuts of up to 60% (much larger than the 21% agreed in July); banks had offered about 40% and warned larger cuts could endanger the banking system.
How much capital might be injected into banks and why does that matter for investors?
Leaders appeared to agree that banks should get about €108 billion to boost their capital base. For investors, stronger bank capital lowers the risk that banks would freeze lending or suffer bigger losses that could ripple through markets.
What is the European Financial Stability Facility (EFSF) and how large could it become?
The EFSF is the euro zone's bailout fund. The summit discussed boosting it to a level that could be as high as €2 trillion so it could cope if larger debt-ridden economies such as Spain or Italy need support.
Why are Germany and France at odds and what does that mean for markets?
France and Germany disagreed particularly over whether the European Central Bank should continue buying Spanish and Italian bonds to support those markets. That split — and Germany's domestic resistance to ECB bond-buying over inflation and independence concerns — made it harder to reach a clear rescue plan and increased market uncertainty.
What political risks in Italy could affect the European bailout effort?
Italy's coalition was under strain after talks over pension reform and raising the retirement age broke down, raising the prospect of political collapse or an election. Leaders pushed for Italy to present a united plan to tackle its €1.9 trillion debt, because a divided government would undermine confidence in the rescue package.
How did the summit developments affect fears of a global recession and market stability?
The prolonged uncertainty and political wrangling, plus the cancellation of a planned meeting of the EU's 27 finance ministers, heightened fears of a double-dip global recession. EU diplomats warned that failure to agree a credible plan could trigger severe market reactions.
What should everyday investors watch for from the emergency summit and its outcomes?
Investors should follow four things reported at the summit: the agreed size of any Greek debt write-down, the final decision on the €108 billion bank recapitalisation, how large the EFSF boost will be (up to €2 trillion was discussed), and whether the ECB will buy more Spanish and Italian bonds — plus political stability in countries like Italy. These outcomes will influence market confidence and risk perceptions.
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