Is Sunday's European debt crisis summit sunk before it even starts?

With German Chancellor Angela Merkel and French President Nicolas Sarkozy at odds over how to leverage bailout funds, hopes for a solution from Sunday's debt crisis summit are wavering.

“Disastrous” was the word Eurogroup chairman and Luxembourg Prime Minister Jean-Claude Juncker used to describe the possibility that Sunday's EU summit in Brussels would not, as expected, come up with a solution to the euro debt crisis.

But it is almost certain that European leaders will not reach the eagerly awaited decision on scaling up the euro bailout fund, the EFSF, at the Sunday meeting. A second meeting has already been called for Wednesday of next week.

Financial experts agree with Mr. Juncker’s opinion that delaying the deal gives the eurozone and its ability to act a bad image. But they differ in their opinion on how to get a grip on the debt crisis as much as the politicians do.

The reason for the delay is disagreement between France and Germany on the methods for giving the euro rescue fund more clout. Both countries see some kind of leverage – increasing the effectiveness of the fund without actually raising the amount of capital it is holding – as the way to regain the trust of investors in eurozone economies. Currently the EFSF holds 440 billion euro, with a guarantee sum of 780 billion. Through leverage, this amount is expected to rise to 2 trillion euro. What they don't agree on is which model of leverage to use.

Bank or insurance model?

France wants to turn the EFSF into a bank, which – healthily capitalized as it is – could then turn to the European Central Bank (ECB) for credit that countries like Greece or Portugal won’t get anywhere else.

Germany is strictly opposed to such a move. Finance Minister Wolfgang Schäuble called it “a license for printing money,” posing the risk of inflation and violating the statutes of the ECB, which is dedicated to impartiality and price stability.

“The eurozone should have such a monetary tool,” says Xavier Timbeau, director of analysis at the Center for Economic Research OFCE in Paris. “The Fed in the United States, the Bank of England, the Bank of Japan – they all intervene by buying up government bonds. Why should we deprive ourselves of such a possibility?”

Michael Wohlgemuth, managing research associate at Freiburg University, disagrees. “Of course the French see the risk of inflation as much as we do. But French banks are heavily exposed to southern European debt. And the country as a whole is about to lose its top credit rating. So France is willing to take risks and eager to spread possible losses.”

Germany’s preference for beefing up the rescue fund – even though it has not been officially confirmed – is an insurance model, in which sovereign bonds would only be partially guaranteed. By insuring only 20 percent of each debt issue, the EFSF could guarantee five times as much.

“There are two problems in the insurance model,” says Mr. Wohlgemuth. “Investors will still not accept government bonds from countries like Greece. And the likelihood that guarantee sums will actually have to be paid is increased.”

Further complications

Desperate attempts to find common ground between France and Germany have not yet yielded any results. On Wednesday, French President Nicolas Sarkozy traveled to Frankfurt for an unscheduled and unsuccessful meeting with German Chancellor Angela Merkel while his wife Carla Bruni went into the hospital and gave birth to a daughter. A government statement by Mrs. Merkel on Friday about the rescue fund was canceled because there was nothing she could tell the public. The two leaders will meet again Saturday evening for a last-minute try at reaching an agreement.

But even if they do, Mrs. Merkel cannot sign any deal in Brussels. The budget committee of the German parliament on Friday voted to object to any changes of the rescue fund unless it is given more time to inspect the proposals. The votes included those from Merkel’s own party, the Christian Democrats (CDU).

Wolfgang Bosbach, a leading CDU member of parliament, explained his uneasiness. “More and more people think that we are not in control any longer, that markets dictate what we are doing. People think we’re acting in self-defense. As lawmakers, we have to regain the initiative," he said.

Wohlgemuth is similarly unimpressed by the proposed leverage of the EFSF. “In the end, no rescue fund of gigantic proportions will solve the crisis. Countries like Italy, Spain, even France, have to persuade international markets that they can control their debts and present a balanced budget. Otherwise this crisis will go on and get worse.”

But this would take time that Europe does not have, according to Mr. Timbeau. “Of course the EFSF is just a means to find breathing space to work on a sustainable solution. But if we can’t make this first step, we won’t be able to make the second.”