European governments moved toward a confrontation over a secondrescue package for Greece, just as a dimming fiscal outlook inPortugal opened a new front in the debt crisis.

Bargaining with Greece over a debt writedown and its economicmanagement came as European Union leaders signed off on key planksof the strategy to end the financial crisis. They agreed toaccelerate the setup of a full-time 500 billion-euro ($659 billion)rescue fund and endorsed a German-inspired deficit-control treaty.Stocks and the euro rose.

Euro leaders left a Brussels summit late yesterday with noaccord over how to plug Greece's widening budget hole and GermanChancellor Angela Merkel voicing frustration with the Athensgovernment's failure to carry out an economic makeover.

“Greece's debt sustainability is especially bad,” Merkel toldreporters. “You have to find a way through more action by the Greekgovernment, more contributions by private creditors, for example,in order to close this gap.”

The summit was the 16th in the two years since the Greek debtemergency provoked a Europe-wide drama, leading to unprecedentedaid packages for Greece, Ireland and Portugal and shatteringEuropean faith that the common currency was indestructible.

After the gathering of leaders, EU President Herman Van Rompuyconvened a smaller group, including Greek Prime Minister LucasPapademos and European Central Bank Executive Board member JoergAsmussen, to weigh the next steps on Greece.

Van Rompuy spoke of the need “to put the current program back ontrack” and said finance ministers will try to hammer out thefollow-up plan — in the works since July — in coming days. Greeceis counting on aid to meet a 14.5 billion-euro bond payment onMarch 20 to escape default.

“The timeline is tight, but we are absolutely focused on thetarget of bringing the negotiations to a successful conclusion bythe end of the week,” Papademos told reporters at 1:30 a.m.today.

The Euro Stoxx 50 Index advanced as much as 0.9 percent todayand the euro strengthened 0.3 percent to $1.3180 at 9:35 a.m. inBrussels, its sixth gain in seven days.

Yet, Papademos said “some difficulties” beset the debt- swaptalks and hinted that donor governments may have to put up moremoney.

Merkel's comments indicated that governments are loath to boostan October offer of 130 billion euros of loans in a second package,forcing investors to absorb net-present-value losses on Greek bondsthat go beyond the 69 percent now on the table.

Greek Feuds

In turn, Greece's feuding political parties face pressure todeliver more savings and to verify in writing that the austerityprogram will be carried out, no matter who wins elections toreplace Papademos's interim Cabinet.

Germany's proposal for an EU-appointed overseer of the Greekbudget prompted consternation in Athens and led to a rejection byother European governments that warned against stigmatizingGreece.

“Greece is a sovereign nation and must enact the promises it'smade,” said French President Nicolas Sarkozy. “Surveillance ofGreece's progress is normal, but there was never any question ofputting Greece under guardianship.”

Investors were seized by fresh doubts about the economic healthof Portugal. Concern that the EU would break a promise not torestructure Portugal's debt pushed 10-year yields up by 2.17percentage points to 17.39 percent yesterday, a euro-era record.The bonds rebounded today, sending the yield down to 16.89percent.

Portugal's debt has been judged “perfectly sustainable” by theEU and International Monetary Fund, Prime Minister Pedro PassosCoelho said. Asked if there is a risk of writedowns on Portuguesebonds, he said: “No, there is not.”

The Greek standoff and Portugal's tottering market punctured thestart-of-year crisis respite that had been nourished by 489 billioneuros in three-year loans infused by the ECB into the bankingsystem.

ECB loans enabled most bond markets to withstand the impact ofcredit rating downgrades by Standard & Poor's. Ten-year yieldsin Italy, with debt estimated at 120.5 percent of gross domesticproduct in 2011, last week dipped below 6 percent for the firsttime since Dec. 6.

Italian Cash

While Italian yields went back up to 6.09 percent yesterday, thegovernment stockpiled cash for the year's biggest bond redemptionby selling 7.5 billion euros of debt, close to its maximum target.The yield was 6.02 percent today.

Leaders completed the fiscal-discipline treaty, which speedssanctions on high-deficit states and requires euro countries toanchor balanced-budget rules in national law. Eight countriesoutside the euro backed the pact, which was shunned by Britain andthe Czech Republic.

ECB President Mario Draghi said the fiscal compact “certainlywill strengthen confidence in the euro area,” calling it “the firststep toward the fiscal union.”

One potential hiccup emerged when Sarkozy said that ratificationof the fiscal treaty in France will likely be delayed until afterelections in April and May that polls show he will lose. Thefront-runner, Socialist Francois Hollande, has vowed to renegotiatethe treaty, saying it is biased toward austerity and would put anadditional squeeze on the economy.

With an eye toward Ireland, Germany pushed through provisionsthat only countries ratifying the fiscal compact will be eligiblefor aid from the permanent bailout fund, the European StabilityMechanism, now set to go into operation on July 1, a year ahead ofschedule.

The permanent fund requires governments to put collective actionclauses into new bond issues as of January 2013, five months laterthan previously planned. The clauses are common in U.S. and U.K.law, enabling a debt restructuring to go ahead by a vote of asupermajority of bondholders, denying a veto right to solitaryinvestors.

“Collective action clauses shall be included, as of 1 January2013, in all new euro area government securities, with maturityabove one year, in a way which ensures that their legal impact isidentical,” according to the text.

While the clauses leave the door open for restructurings, thefund's statutes deem write-offs “exceptional” and subject to IMFstandards, the text says. It tones down language on “private sectorinvolvement” — code for forcing bondholders to take losses ongovernments that fall too deeply into debt.

Leaders sidestepped mounting pressure to raise the ceiling onrescue lending from 500 billion euros once the permanent fund goeson line, sticking with plans to handle that question at the nextsummit on March 1-2.

Luxembourg Prime Minister Jean-Claude Juncker, Europe'slongest-serving leader and the head of the panel of euro financeministers, summed up two years of crisis-fighting: “If I wasn'toptimistic you could have reported about my suicide monthsago.”

Bloomberg