Sarkozy, Merkel seek stricter EU treaty

Seeking to restore confidence in the euro, the leaders of France and Germany jointly called for changes to the European Union treaty so that countries using the euro would face automatic penalities if budget deficits ran too high.

Stock prices rose and borrowing costs for European governments dropped sharply in response to the changes proposed by French President Nikolas Sarkozy and German Chancellor Angela Merkel. They said their proposals would prevent the kind of out-of-control spending and borrowing that led to the debt crisis that is engulfing Europe and threatening the global financial system.

Leaders of all 27 EU countries will discuss the proposals at a Friday summit in Brussels. If there is widespread support, that would be an important first step in bringing an end to the crisis, which has dragged on for more than two years.

"Our wish is to go on a forced march toward re-establishing confidence in the eurozone," Sarkozy said at a press conference, with Merkel at his side. "We are conscious of the gravity of the situation and of the responsibility that rests on our shoulders."

EU treaty changes could take months, if not years, to implement and don't wipe away the mountains of government debt dragging down Europe's economy. But preliminary buy-in Friday from the 17 countries that use the euro could set the stage for further emergency aid from the European Central Bank, the International Monetary Fund or some combination.

"The onus is still on the ECB to print money to make huge loans or bond purchases and draw a line under the crisis," said Jennifer McKeown, senior European economist at Capital Economics. "Perhaps if other member states sign up to Merkel's and Sarkozy's proposals this week the (ECB) will step in."

March deadline

Sarkozy pledged to have a revised EU treaty ready for signing by March. It would then need to be ratified in each country, which could mean lengthy parliamentary debates or national referendums in some cases.

"A lot depends on the specifics and how these are going to be framed by lawyers," said Piotr Maciej Kaczynski, an expert on EU constitutional issues at the Center for European Policy Studies in Brussels.

At the very least, it could take at least 18 months to ratify a new treaty once it has been signed by all heads of state, said Kaczynski. "That is a much longer timeline than what markets might want," he said.

Bond-market analysts said they remain skeptical of Europe's ability to prevent future profligacy. "If you say it strong enough and often enough maybe people will believe it," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. "But I don't think the markets believe 'Merkozy' at this point."

EU governments reacted with caution.

No other EU leaders came out against the Franco-German proposals, but no strong statements in favor were immediately forthcoming. The reaction from Austrain Finance Minister Harald Waiglein was fairly typical: "There is nothing here that contradicts our position," although more details are needed, he said.

The modern EU is based on a set of treaties, dating as far back as the 1950s, when the project of consolidating the continent began. The treaties detail the rules that countries must follow and outline the mandates of institutions like the ECB. The most recent was the Lisbon Treaty, which was ratified in 2009, giving additional powers to the European Commission and European Parliament.

Sarkozy said he and Merkel would prefer that the treaty changes they're proposing be agreed to by all 27 members of the EU. But he left the door open to an agreement only among the 17 euro countries and anyone else "who wants to join us."

Proposed changes

Sarkozy and Merkel discussed several broad changes for the EU treaty, but failed to provide much detail. The changes they outlined included:

• Introducing an automatic penalty for any government that allows its deficit to exceed 3 percent of GDP. A majority of nations would need to oppose automatic sanctions for a country to avoid them.
• Governments are supposed to abide by the deficit limit under existing rules, but many, including France, have flouted it. Further, punishment only occurs after a majority of euro countries votes to impose them.
• Requiring countries to enshrine in law a promise to balance their budgets.A key issue for the proposal's final approval will be how much flexibility countries can have to run temporary deficits during economic downturns.
• Pledging that any future bailouts would not require private bond investors to absorb a part of the costs, as was the case for the Greek bailout. Germany had earlier insisted that Europe's permanent bailout fund would demand private investors take losses if a country in the future needs rescuing.
• Promising to not criticize or otherwise comment on the work of the ECB. This is intended to ensure the bank's independence and its ability to act without pressure from European leaders.

Sarkozy said more details would be included in a letter sent Wednesday to European Council President Herman Van Rompuy.

After Sarkozy and Merkel spoke, stocks rose and borrowing rates for governments across Europe plunged, indicating a sharp rise in investor confidence in the continent's ability to resolve the crisis.

France's CAC-40 index climbed 1.2 percent, Germany's DAX rose 0.4 percent and markets outside of Europe also pushed higher, with the Dow Jones industrial average up 1.2 percent.

French banks, which have been hit hard this year over fears about their large exposure to the government bonds of financially weak countries like Greece, saw some of the biggest gains.