France lobbied on Sunday to overcome German opposition to giving the European Central Bank a central role in bolstering the euro zone's bailout fund, arguing it was the only way to draw a definitive line under the widening debt problems.
Setting a Wednesday deadline for a comprehensive deal to resolve the euro crisis, leaders on Sunday were seeking agreement on a means to boost their 440 billion euro ($610 billion) EFSF rescue fund by enough to support the region's undercapitalized banks and stop the crisis sucking in big economies such as Italy and Spain.
Paris -- with support from most of the 17 euro zone states, including Italy and Spain -- argues the European Financial Stability Fund should be given a banking license, allowing the fund to leverage its lending capacity by tapping almost unlimited credit from the ECB's lending window.
Germany, fiercely protective of the independence of the Frankfurt-based ECB, has argued that using it to leverage the EFSF would violate its mandate, leading to an unusually public disagreement between the two powers which normally chart the course for the bloc. The ECB also opposes taking on the role.
Finland and the Netherlands -- which have emerged as hardliners opposed to the rising cost of euro zone bailouts -- have sided with Germany. But a range of concerned euro zone member states have rallied behind France's position.
The French are not letting go of it, and insist on their idea. Their position has not changed, one European diplomat from a nation sympathetic to Paris's view said on Sunday.
Eurogroup chair Jean-Claude Juncker, the prime minister of Luxembourg, acknowledged the diplomatic stalemate over the crisis was damaging for Europe: The outside impression is disastrous.
In an attempt to lay the issue to rest, German officials have said that only two options for leveraging the EFSF remained on the table ahead of Wednesday's self-declared deadline.
The first involves using the EFSF to guarantee a share of losses on at-risk euro zone bonds, allowing it reinforce investors' confidence while maximizing its resources. The second is bolstering its firepower via a Special Purpose Vehicle capitalized by donors such as China or Brazil.
The prospect of allowing foreign nations to decide the fate of Europe has alarmed the Europe Commission, and this option appears unlikely to win through, not least because of the implications it has for European sovereignty.
France is insisting there are legal means to avoid the ECB's participation violating EU rules against it directly financing governments -- a process known as monetary financing -- and still hopes to win Berlin round.
Paris has dangled the prospect of other concessions sought by Berlin, such as losses of up to 60 percent for banks holding Greek government bonds, in the hope of striking a deal.
The Germans are against any violation of the rules of the ECB ... but this would not necessarily be incompatible, said one French source. The ECB's participation would greatly increase the effectiveness of any solution.
One factor playing in France's favor is that many economic analysts think the leveraging plan that remains on the table is flawed, and believe the ECB probably is the best solution -- only the ECB has the unlimited firepower to convince erratic financial markets that the crisis can be contained.
The International Monetary Fund also has sympathy with France's position, and all sides want to see a resolution by the G20 summit in Cannes on November 3-4.
ECB IN FLUX
The stumbling block remains that any deal must be acceptable to German public opinion and the country's parliament, which was handed more sway over any EU deal by a Constitutional Court ruling last month.
As for the ECB itself, while it has baulked at directly intervening to bolster the EFSF under outgoing President Jean-Claude Trichet, that could change from November when he will be replaced by Mario Draghi, the governor of the Bank of Italy.
The arrival of self-styled pragmatist Joerg Asmussen as Germany's candidate to replace the hawkish Juergen Stark on the six-man committee that runs the ECB day-to-day, plus the expected arrival of another Frenchman to numerically replace Trichet, could also incline it toward a more flexible approach.
The ECB has staked out similar 'red lines' in the past -- such as its refusal to buy government bonds or for a write-down of Greek debt -- only to be forced to cross them as the crisis in the shared currency zone has lurched from bad to worse.
Pressure has grown from Europe's partners in the G20 to find a definitive solution after months of wrangling which have roiled markets and threatened the world economy, with China and the United States voicing frustration in recent days.
The issue here is not Greece, it is how to build an effective firewall to avoid contagion in the rest of the euro zone, said one G20 source.
To do that you need size and speed. The problem with a SPV is that it would take time to put together and it would not necessarily be big enough. Only the ECB would have the size and the speed you need, he said. ($1 = 0.720 Euros)
(Additional reporting by Francesca Landini; Writing by Daniel Flynn; editing by Luke Baker/Ruth Pitchford)