Treasury Secretary Timothy Geithner holds talks with European finance ministers on Friday on the possibility of leveraging the euro zone's bailout fund to help resolve the debt crisis.

Washington set up an emergency fund to support U.S. lenders during the global credit crisis. With signs of stress in Europe now, the European Central Bank and those of Britain, Japan and Switzerland joined forces on Thursday to reintroduce three-month dollar liquidity operations in the fourth quarter.

The coordinated action boosted the euro and global stocks, prompting market speculation that European policymakers may take bold steps to deal with a crisis that is now threatening Italy, the euro zone's third-biggest economy.

After rising 2 percent on Thursday, world stocks rallied in Asia on Friday. The MSCI world stock index rose 0.6 percent in Asia to a one-week high, marking its fourth straight daily gain. The euro held on to Thursday's strong gains.

The central bank move was exactly what is needed since the world has entered a dangerous phase of the crisis, said International Monetary Fund chief Christine Lagarde. She repeated her call for European countries to recapitalize their banks.

Geithner holds talks with EU ministers in Poland and will propose that the European Financial Stability Fund, the 440 billion euro fund set up in May 2010, be used in a similar way to an emergency loan fund created by the U.S. Treasury and the Fed in 2008 to thaw frozen credit markets, sources said.

Geithner will probably insist on the importance of leverage to have more funds to ringfence the big Europeans, Italy and Spain, and to find a solution for Greece, an EU official told Reuters ahead of the meeting in Wroclaw.

The treasury secretary is expected to expound the model of the Term Asset-Backed Securities Loan Facility (TALF) that U.S. financial authorities used to jump-start the asset-backed securities market.

Under TALF, the Treasury offered up to $20 billion in credit protection to the New York Federal Reserve Bank, where Geithner was then president, allowing it lend up to $200 billion. In return, the New York Fed took in asset-backed securities as collateral with a haircut.

TALF was credited with restarting frozen U.S. markets for securities backed by car, student and small business loans and leases. By taking in paper that had no other buyers at the time, the Fed acted as market maker. No losses were reported on the program.

While it remains unclear whether the same mechanism could be used to leverage Europe's bailout funds, one analyst said EFSF money could be used to guarantee a portion of potential losses on euro zone sovereign debt bought by the ECB, providing more purchasing clout than if it just bought the bonds in the secondary market with money on hand.

It is possible to leverage the EFSF so as to expand its headline capacity to support sovereign bonds, for example through the use of partial guarantees against first losses, said Sony Kapoor, managing director of think tank Re-Define.

One difficulty is that leveraging a fund that is underwritten by guarantees from euro zone member states could increase liabilities across the board, putting pressure on the triple-A credit rating of countries such as France.

ANOTHER NO FOR EURO BONDS

Leveraging the EFSF would be a radical new approach in the crisis at a time when financial markets are fixated on the possibility of the euro zone introducing jointly issued bonds, even though such a move is strongly opposed by Germany and unlikely to happen any time soon.

German Chancellor Angela Merkel again bluntly rejected such bonds as a solution to the crisis on Thursday, saying that collectivizing debts would not solve the problem.

In order to bring about common interest rates, you need similar competitiveness levels, similar budget situations. You don't get them by collectivizing debts, she said.

The European Union's top economic official meanwhile said he expected international lenders to be able to recommend by the end of the month releasing a vital next tranche of aid to Greece, warding off the threat of an imminent default.

While that may keep Greece afloat until it gets a second bailout package from the euro zone, the finance minister said the country would remain mired in recession through 2012, the fourth year in a row, a contraction that is only likely to fuel popular outrage at the austerity drive.

Lagarde was more cautious on Greece's progress, saying Athens had partially implemented reforms under its EU/IMF bailout program but must make more progress to secure release of the next 8 million euros in emergency loans.

If there has been no implementation, we don't pay, she warned.

On a conference call with Greek Prime Minister George Papandreou on Wednesday, Merkel and French President Nicolas Sarkozy voiced their support for keeping Greece in the euro zone and continuing financial assistance provided it sticks strictly to austerity measures to meet its fiscal targets.

EU Economic and Monetary Affairs Commissioner Olli Rehn said he now expected an EU/ECB/IMF troika of inspectors to complete their review of Greece's fiscal targets by the end of the month.

(Additional reporting by David Lawder in Washington; Writing by Luke Baker, Paul Taylor and Neil Fullick; Editing by Alex Richardson)