Germany's refusal to embrace new measures has set the stage for a crucial European summit that appears destined to dash the hopes of markets looking for concrete action that would ease the region's financial crisis.
Crisis fatigue set in just three days ahead of the meeting of European Union leaders in Brussels, aimed at halting the contagion, though observers fear it will fail, as have others. The crisis has spread from the early victims – Greece, Ireland and Portugal – to Spain and Italy, catching up Cyprus in the process.
Global markets plunged Monday as Spain formally sought aid for its distressed banks, Cyprus became the fifth country of the euro zone to seek a bailout, and the new Greek finance minister, Vasillis Rapanos, resigned due to ill health.
With prime minister Antonis Samaras also in hospital, for eye surgery, Greece's role at the summit Thursday and Friday is in total disarray, just as the new government is desperate to renegotiate the bailout package whose austerity measures have pushed the economy to the brink of depression.
German Chancellor Angela Merkel, who has not wavered from her mantra of fiscal discipline through the crisis, reiterated that euro bonds and region-wide bank deposit insurance will not be on the table at the Brussels summit. Both measures have been championed by French President François Hollande and Italian Prime Minister Mario Monti.
Euro bonds would pool debt of the 17 EU countries that use the euro. Exploiting the top credit rating of Germany, the bonds would lower the funding costs of Spain, Italy and other weak members of the monetary union, while raising Germany's. Deposit insurance has been touted as a way to arrest slow-motion bank runs in Greece and Spain before they turn into a stampede, potentially destroying banks throughout the euro zone's Mediterranean frontier.
On Monday, Moody's Investors Services downgraded the long-term debt and deposit ratings for 28 Spanish banks.
At a conference in Berlin, Ms. Merkel called euro bonds and joint deposit insurance "economically wrong and counterproductive," and said they would not pass German constitutional muster.
Instead, she pleaded for tighter European financial oversight and economic reform measures.
"It's not a bold prediction to say that in Brussels most eyes – all eyes – will be on Germany again," she said. "I say quite openly, when I think of the summit on Thursday, I'm concerned that once again the discussion will be far too much about all kinds of ideas for joint liability and far too little about improved oversight and structural measures."
Her comments came three days after a disappointing mini-summit in Rome, which produced a vague pledge from Germany, France, Italy and Spain for a growth package valued as high as €130-billlion ($167-billion) and puffed-up rhetoric about using any means possible to keep the euro zone intact.
The expectations for another disappointing summit pushed down the top European and North American indexes. The FTSE-100 shed 1.1 per cent and the euro fell half a percentage point to $1.25 (U.S.). Oil and copper fell, though gold rose.
"Whenever we've had an EU summit in the past, equity markets have usually rallied into the meeting on expectations that EU leaders would come up with some policy response to ease the crisis," said Michael Hewson, senior market analyst in London with CMC Markets. "Having been disappointed on so many previous occasions, investors have chosen to lower their expectations and markets have slid sharply lower today."
Cyprus's bailout had been expected for months because the country's economy, and its banks, are heavily exposed to the plummeting Greece economy and nearly worthless Greek sovereign bonds. The plea for help came Monday, the same day that Fitch, the ratings agency, dropped the country's sovereign rating to junk status and just before a deadline to recapitalize one of its largest banks.
"The purpose of the required assistance is to contain the risks to the Cypriot economy, notably those arising from the negative spillover effects through its financial sector, due to its large exposure to the Greek economy," the government, led by President Demetris Christofias, said in a statement.
The total value of the bailout was not known Monday. Cyprus, however, needs €1.8-billion by the end of the week to recapitalize Cyprus Popular Bank. The amount is equivalent to a hefty 10 per cent of Cyprus's gross domestic product.
Cyprus's request came as Spanish Economy Minister Luis de Guindos formally asked the European Union for up to €100-billion to recapitalize Spain's banks, among them Bankia, the fusion of seven ailing regional savings banks that is short €19-billion of capital. The loans will come from one or both of the European bailout funds, the European Financial Stability Facility and the new European Stability Mechanism, which is to be launched next month.
The loans will come with strict conditions. Olli Rehn, the EU's top economics official, said the conditions "will be focused on specific reforms targeting the financial sector, including restructuring plans which must fully comply with EU state aid rules."
With euro bond and joint deposit insurance ruled out by Germany, the leaders' summit might outline a plan for a banking union, including a European bank supervisor. The leaders may authorize the two bailout funds to directly recapitalize the banks, instead of lending the money to sovereign states, whose governments would then disperse the money themselves.
Economists, however, do not expect a breakthrough even though European leaders, notably Italy's Mr. Monti, have been pushing hard for a crisis-ending mechanism. Unless there is a clear vision, he warned, "there would be progressively greater speculative attacks on individual countries, with harassment of the weaker countries."