Europe's leaders today cap their latest effort to check thefinancial crisis that claimed Cyprus this week as its fifthvictim.

Euro-area finance ministers set the stage for today's gatheringin Brussels of the European Union's 27 chiefs, approving Cyprus'sbailout and detailing how they would aid Spanish banks. Consensusbreaks down on safeguarding governments in Spain and Italy, withGerman Chancellor Angela Merkel rejecting calls to do more to cuttheir borrowing costs.

“People have been imagining too many moments of truth over thepast few years, and Europe has been able to continue kicking thecan,” said Sebastian Paris-Horvitz, chief market strategist at HSBCPrivate Bank Suisse in Paris. “The issue today is that indeed theproblem has become much bigger. We are not talking about tinyGreece but big Spain and even bigger Italy.”

Merkel is increasingly isolated as French President FrancoisHollande, Italian Prime Minister Mario Monti and Spanish PremierMariano Rajoy unite to push for quicker action to ease the crisisthat emerged in Greece in late 2009. The three leaders back thecreation of euro bonds and are pushing for measures to spur growth.Merkel met Hollande last night in Paris and will travel to Rome tomeet Monti on July 4.

“The key negotiators, including the German chancellor, do notreally understand the timeframe we're working under,” NiallFerguson, a professor of economic history at Harvard University,said at a conference yesterday in London. “The timeframe forfinancial crises is days. The timeframe for structural reforms isyears.”

Stocks and the euro dropped before the summit. The Stoxx Europe600 Index retreated 1 percent to 243.5 as of noon in Brussels. Theeuro fell 0.35 percent to $1.2425.

Italy today paid a yield of 6.19 percent in an auction of10-year debt, the most since December. The Treasury also sold afive-year bond to yield 5.84 percent, compared with 5.66 percentlast month.

The EU leaders are due to discuss a plan seen playing out overmore than a decade for closer European integration. The blueprint,written by EU President Herman Van Rompuy, centers on commonbanking supervision and deposit insurance, along with a“criteria-based and phased” move toward joint debt issuance. Theblueprint also suggests that the EU could impose upper limits onannual budgets and debt levels of nations that use the euro.

Merkel's Doubts

Merkel, also the focus of pressure at the Group of 20 nationssummit 10 days ago, yesterday shut the door to joint euro-areabonds as a means of lowering Spain and Italy's borrowing costs,saying they are the “wrong way” to achieve the greater Europeanintegration needed to stem the debt crisis.

Speaking three hours after Rajoy made a plea for help for Spainat the summit, Merkel said that euro bonds, euro bills and debtredemption funds are unconstitutional in Germany and economically“wrong and counterproductive.”

“I fear that at the summit there will be much too much talkabout mutual liability and far too little about improved oversightand structural measures,” Merkel told lower-house lawmakers inBerlin yesterday. “Oversight and liability have to go hand in hand.There can only be joint liability when adequate oversight isensured.”

Finnish Prime Minister Jyrki Katainen said “new structures” areneeded in the euro area to combat the sovereign-debt crisis.

“We have to be open minded when looking at the future of theeuro area and the future of the EU but it doesn't mean that weshould mutualize liabilities,” Katainen told reporters today inBrussels, adding “We don't like euro bonds.”

Spanish 10-year bond yields rose to 6.97 percent, nudging the 7percent level that forced Greece, Ireland and Portugal to call forsovereign bailouts. Equivalent German bonds yield about 1.5percent.

A German government official shrugged off those rising borrowingcosts, telling reporters in Berlin today that bond yields go up anddown. Italy and Spain have financed much of their needs for theyear so there is no need for excessive panic, the official said oncondition of anonymity because the summit negotiations will beprivate.

'Not Enough'

“It is not enough that we paint the future differently but weneed to make the decisions that we need right now,” LuxembourgPrime Minister Jean-Claude Juncker told reporters in Brussels lateyesterday.

Merkel doesn't plan to extend her stay at the summit throughthis weekend, the German official said. Merkel is due to return toBerlin tomorrow and doesn't expect to change her plans, theofficial said.

Cyprus, which may need as much as 10 billion euros due to thedamage to its banking system from losses on Greek bonds, won'twithdraw its bailout request, a possibility that had been reportedin local media, Finance Minister Vassos Shiarly said.

While pursuing EU aid, Cypriot officials have investigated theprospect of a loan from Russia or China. Shiarly said this searchwill continue.

While Merkel said that she welcomed the Van Rompuy proposals andagreed with his four building blocks toward integration, sherebuffed any notion Germany shoulder the cost.

“I decisively reject the presumption in this report that theprinciple of collectivization takes priority,” she said. Rather,individual countries must “keep to agreed rules” and raise theircompetitiveness through structural reforms, using the best inEurope as the standard “rather than mediocrity.”

Spain formally requested a European bailout for its banks onJune 25, gaining a credit line of as much as 100 billion euros($125 billion). The finance ministers yesterday estimated the needat as much as 62 billion euros, which could be provided by thetemporary bailout fund, the European Financial Stability Facility,until the permanent European Stability Mechanism is up and running.The bailout program would then be transferred to the ESM.

Whether the aid would take precedence over other debts in theevent of default may have to be settled by the government chiefs asfinance ministers from Germany, Finland and the Netherlandsresisted pressure to drop that condition.

Juncker, who chairs the group of the 17 euro finance chiefs,signaled a possible agreement. “I expect that we can calm marketson this point in the coming days,” he said.

Rajoy said he will fight so that rescue loans “aren't superiorto the rights of other creditors of public debt.”

The Spaniard also backs a so-called banking union, which he saysincludes joint deposit-guarantee funds and would allow Europe'srescue funds to recapitalize banks directly without going via thegovernment. German officials have rejected those proposals.

“It all hinges on her,” said Ferguson of Merkel. “She has torealize the cost of disintegration to Germany would bemind-blowing.” Whatever happens, “Germany pays,” he said. “Do theypay through massive defaults or fiscal transfers?”

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