With less than 24 hours before the meeting of government leaders in Brussels, banking representatives and European officials were negotiating over what losses banks should accept.
The banks have taken a hard line and warned that the write-off of debts they are being asked to agree to — about 55 percent — could result in a default or
similar shock to the financial system, something European officials are desperate to avert. That has prompted a search for so-called complementary measures that might help to sweeten the deal for the bankers.
Stock markets in Europe and the United States fell as investors feared that the meeting would not deliver a plan ambitious enough to solve Europe’s financial crisis.
The Standard & Poor’s 500-stock index closed down 2 percent. After reaching a bottom on Oct. 3, the index has risen 14 percent on signs that the American economy might be pulling out of recession.
But analysts said the markets were still vulnerable to turmoil in Europe, where the long political uncertainty was already unsettling credit markets and damping growth even in core economies like France. Interest rates on bonds of countries like Italy and Spain have risen sharply.
A failure to resolve the crisis definitively at the meeting on Wednesday, particularly by maximizing the firepower of a proposed $600 billion bailout fund, risks upsetting markets, analysts said.
“Europe still has the possibility of dragging the U.S. back into recession,” said Sam Stovall, a strategist at S.& P. Equity Research in New York. “What is going to be needed to keep markets happy will be funding” for the bailout fund “that goes well beyond $1 trillion to ring-fence the debt problems and allow the other economies to move forward,” he said. Italy, meanwhile, has come increasingly under the spotlight as investors doubt the government’s commitment to reduce its 1.9 trillion euro, or $2.6 trillion, debt.
European Union leaders want Prime Minister Silvio Berlusconi of Italy to present firm plans on growth and debt reduction in time for the meeting.
Italian news agencies reported late Tuesday that Mr. Berlusconi had reached an accord with the Northern League, his principal coalition partner. The league’s leader, Umberto Bossi, said earlier Tuesday that Mr. Berlusconi’s government could fall over the issue of raising the standard retirement age to 67 from 65, a move Mr. Bossi opposed.
With the clock ticking, a senior German official, Jörg Asmussen, and a French counterpart, Ramon Fernandez, joined intensive discussions with the banks in Brussels.
Under one of about five plans being debated, Greek bonds might be swapped for those of much lower face value issued by the euro zone’s bailout fund, according to two officials briefed on talks, who added that the idea might make a write-down more attractive for the banks.
The Institute of International Finance, which represents the banks involved, intends to send its own proposal to European leaders on Wednesday, according to a person with direct knowledge of the negotiations. That would involve banks taking more than the 21 percent loss they agreed to in July, in exchange for sweeteners that would help mitigate some of the additional loss, such as allowing banks to buy bonds from the bailout fund.
“It’s clear that circumstances have changed too much for the July 21 agreement to work at this point,” said the person, who spoke on condition of anonymity because the talks were continuing. “We are prepared to adjust to new circumstances within limits. The question is, are the governments prepared to meet us halfway?”
Adding to the mood of anxiety, a meeting of European finance ministers on Wednesday, which was to precede the second gathering in a week of European leaders, was abruptly canceled on Tuesday by Poland, which holds the bloc’s rotating presidency.
Though that was a recognition that the deal with the banks would not be ready by Wednesday morning, it did not mean that agreement was impossible later in the day, when the leaders meet, diplomats and officials said.
The summit meeting will still take place and “work on the comprehensive package of measures to curb the sovereign debt crisis” will continue there, a statement by the Polish presidency announcing the cancellation said.
Those measures include a recapitalization of European banks and augmenting the 440 billion euro bailout fund, probably to more than 1 trillion euros. That would likely be achieved through two methods that probably would run together.
Though France is reluctant to bring other powers, like China, into the heart of the euro zone, it will probably have to overcome its reservations because of the gravity of the situation.
Though officials expect the European Central Bank to play a role in bond buying, at least in the short term until a new system is established, Germany is resisting any firm reference by leaders to this as part of the deal.
“It is important to have clarity on private sector involvement,” Amadeu Altafaj Tardio, a European Commission spokesman on economic and monetary affairs, told reporters in Brussels. “All the issues are interlinked.”
The statement of the Polish presidency canceling the finance ministers’ meeting was issued just hours after a declaration that the meeting would proceed, and increased the impression of confusion in European decision-making, sending stock markets and the euro lower.
Diplomats and officials said that the cancellation had less to do with the substance of the negotiations and more to do with internal politics of the 27-country European Union, of which only 17 countries are members of the euro currency zone.
“It’s unfortunate handling by the Polish presidency, and bad news because the markets have tanked,” the diplomat said on condition of anonymity because of the delicacy of the subject. But the diplomat said the summit meeting should not be affected.
While political leaders fumbled toward a solution, analysts and bankers began to contemplate the consequences if there is an agreement to sharply cut the Greek debt load and require banks to raise their reserves.
A reduction of 50 percent to 60 percent in the value of Greek bonds would be hard to dress up as anything but a default, analysts said. The resulting “credit event” would activate insurance that investors have bought on Greek debt, known as credit-default swaps.
Information was incomplete on which banks might have issued the swaps and could be vulnerable to losses, creating an extra element of risk.
Among policy makers and analysts, nervousness was palpable that there could be dire consequences that are impossible to predict.
“We have created a world that is noncomputable because it is too complex,” said Fredmund Malik, chairman of Malik Management, a consultancy in St. Gallen, Switzerland.Stephen Castle reported from Brussels, and Jack Ewing from Frankfurt. Liz Alderman contributed reporting from Paris, and Elisabetta Povoledo from Rome.