France and Germany Split on Crisis Solution

A French-German split over Europe’s rescue strategy emerged as finance ministers prepare to meet in Brussels tomorrow under pressure to craft a solution to the region’s debt crisis.

With a summit scheduled two days later, a disagreement over the European Central Bank’s role threatens to stymie progress on the banking and economic questions needed to deliver the comprehensive strategy demanded by global policy makers. Luxembourg Prime Minister Jean-Claude Juncker, who chairs the group of euro-area finance ministers, indicated an impromptu meeting of European leaders in Frankfurt last night failed to resolve differences. “We are still meeting,” he said as he departed.

French President Nicolas Sarkozy, whose wife was reportedly giving birth to his first daughter, jetted into Frankfurt to meet with officials as they attended an event to honor outgoing ECB President Jean-Claude Trichet. Sarkozy, German Chancellor Angela Merkel and International Monetary Fund Managing Director Christine Lagarde left the event at the Frankfurt Opera House without commenting.

“Many expect to be underwhelmed at the weekend,” David Mackie, chief European economist at JPMorgan Chase & Co. (JPM), said in an interview. “If they haven’t settled the leverage issue, then the sense of being underwhelmed will be overwhelming.”
Euro Weakens

The euro weakened and Asian shares fell on the split over Europe’s rescue strategy. The euro dropped 0.2 percent to $1.3733 at 10:31 a.m. in Brussels. The MSCI Asia Pacific Index lost 1.8 percent to 115.31.

French Finance Minister Francois Baroin disclosed to reporters the depth of the disagreement over the ECB which, along with Germany, has rejected using its balance sheet to bolster the 440 billion-euro ($607 billion) European Financial Stability Facility.

While Germany endorsed enabling the EFSF to insure a portion of cash-strapped nations’ bond sales, Baroin said France wants to turn it into a bank that could tap the ECB.

“Everyone knows the reticence of the central bank and everyone also knows of the reticence of the German position,” Baroin said. “For us it is and will remain the most effective position. The Americans do it, the British do it.”
Primary-Market Purchases

Trichet has been a key part of Europe’s crisis-fighting effort, reluctantly pushing the ECB to buy bonds in the secondary market, a role it may be forced to keep under a revamped strategy.

Primary-market purchases by the enhanced European Financial Stability Facility generally should be limited to no more than 50 percent of the final issued amount, according to draft guidelines for the backstop from the European Commission, the European Central Bank and senior officials from the 17 euro- region nations, obtained by Bloomberg News. The EFSF should participate at the weighted average price of the auction, it said.

“That means that EFSF’s share is no larger than the share bought by the market,” the draft says. “It gives an incentive to the issuer to accept market bids, because for each million of accepted market bids the member state will receive an additional million from EFSF.”
‘Disconcerting’ Pace

Canadian Finance Minister Jim Flaherty said European leaders’ slow pace toward a solution is “disconcerting,” while adding they have the “sense of urgency required.” The rescue fund isn’t sufficient to deal with the crisis and will need to be leveraged, he told reporters in Ottawa yesterday.

The disagreements among policy makers came as banks lobbied against forced recapitalization and deeper writedowns on Greek debt.

While Merkel this week sought to lower expectations that the crisis-fighting effort would climax at the Sunday summit in Brussels, Group of 20 finance chiefs last week set the meeting as a deadline for action. Failure risks a global economic slump, they said.

The world economy is facing the “threat of profound and traumatic disruption,” Norman Chan, chief executive of the Hong Kong Monetary Authority, said in a speech published on the de facto central bank’s website.

Also attending the event in Frankfurt last night were Mario Draghi, who replaces the retiring Trichet on Nov. 1, European Union President Herman van Rompuy and European Commission President Jose Barroso. Baroin and German finance minister Wolfgang Schaeuble were there as well. No statement was issued.
Bank Backstop

Policy makers are struggling to end a crisis that began in Greece two years ago this week. In Athens yesterday, protesters clashed with police outside Parliament before Prime Minister George Papandreou won a preliminary vote on a new austerity package. The final vote is scheduled for today.

The issues frustrating European authorities include how to write down of as much as 50 percent on Greek bonds, setting up a backstop for banks and finding a continued central bank role.

Van Rompuy praised Trichet for taking “unconventional” steps and not being beholden to dogma.

“Independence doesn’t mean detachment from political decision-making,” Van Rompuy said at the Trichet farewell ceremony. “Monetary policy cannot be conducted in a social and political void. The central bank’s independence is a right, but also entails duties.”