European officials are considering steps previously rejected byGermany, including the use of precautionary credit lines, toprevent the spread of the region's debt crisis, a person close tothe talks said.

Other options up for discussion at tomorrow's Brussels summitinclude enabling the main 440 billion euro ($626 billion) rescuefund to lend to recapitalize banks, said the person, who declinedto be named because negotiations are in progress. Nothing will bedecided until leaders convene.

Together with a second Greek aid package, the goal is to proveto markets that Europe has the will and the tools to prevent the21-month sovereign debt crisis from engulfing Spain and Italy. Theeuro today rose against the dollar for a second day and Spanish andItalian bonds also gained as investors signaled optimism thatpolicy makers are moving toward a deal.

“There needs to be a program with a certain amount of shock andawe to impress the market that the leaders are on top of thecrisis,” said Robin Marshall, a London-based money manager at Smith& Williamson Investment Management in London.

The start of tomorrow's summit was delayed by an hour to 1 p.m.to allow more time for preparations, an EU official said. A workinggroup meeting of euro-area officials was also pushed back to 9 a.m.tomorrow from 6 p.m. today, the official said, speaking oncondition of anonymity because negotiations are still underway.

Pressure on Merkel
Talk of new rescuemeasures raises the pressure on German Chancellor Angela Merkel,who vetoed proposals to put more weapons in the rescue fund'sarsenal earlier this year amid misplaced optimism that Greece wasturning the corner.

Merkel will meet today with French president Nicolas Sarkozy,who has swayed her stance on crisis-fighting in the past. U.S.President Barack Obama weighed in yesterday on a phone call withhis German counterpart during which they agreed Europe needed todeal with its problems “effectively.”

Discussions of more flexibility for the European FinancialStability Facility come on the heels of last month's accord toboost its lending power to its original target. InternationalMonetary Fund-style credit lines would better able countries withstronger fundamentals than Greece to ward off speculativeattacks.

Stress Tests
Rescues for Ireland andPortugal partly funded by the EFSF already include some funds forhelping banks, while Greece's separate program also earmarks aidfor its banks. Greater support for European banks may be necessaryafter stress tests on 90 left as many as 24 under pressure to showthey can raise capital. Investors said Deutsche Bank AG, UniCreditSpA and Societe Generale SA should consider boosting capital afterscraping through the probes.

As floated by finance ministers on July 11, the leaders willalso look at empowering the EFSF to buy bonds in the secondarymarket and to enable crisis-hit countries to buy back their owndebt, measures that may help reduce nations' borrowing burdens.Spanish Finance Minister Elena Salgado, who is battling to preventthe crisis from engulfing her country, today said she supportedsuch steps.

The extra yield that investors demand to hold 10-year Spanishbonds over German bunds rose to a euro era record of 367 basispoints on July 18. The Italian spread hit 332 basis points.

'Make-or-Break'
With Greek Prime MinisterGeorge Papandreou saying in an interview yesterday that leadersface a “make-or-break” moment at the summit, success hinges ongoing beyond a second Greek package, which national officialscontinue to work on today. The IMF said yesterday that Greece'scrisis still risks contaminating the rest of the euro region evenif officials avert a default there.

The main sticking point is how to get bondholders and banks tofoot a share of the bill without sparking a new wave of financialturmoil. European Central Bank President Jean-Claude Trichet saysany default risks sparking a crisis on a par with the collapse ofLehman Brothers Holdings Inc. German policy makers, who arereluctant to keep forcing their taxpayers to aid the spendthrift,signal a restructuring may be unavoidable.

EU officials are aiming to narrow down a list of options to bepresented to the leaders in Brussels, the person familiar with thetalks said. Sarkozy and Merkel will meet for talks and dinner inBerlin, repeating the one-on-one talks the leaders of thetwo-largest euro-area economies have adopted in the past whentrying to steer their region out of trouble.

One approach would see governments taxing financial institutionsto fund a new bailout in addition to a voluntary rollover of Greekdebt, according to an EU paper obtained by Bloomberg News. Theother two options in the document involve either a partial oroutright default.

Bloomberg News

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