June 29, 2012 / By STEPHEN FIDLER in Brussels and WILLIAM BOSTON,MATTHEW KARNITSCHNIG and GERARD BAKER in Berlin/ WSJ

European leaders at a two-day summit in Brussels said they would speed up plans to create a single supervisor to oversee the euro zone's banks, and agreed on measures aimed at reducing soaring borrowing costs for Spain and Italy.
 

After 14 hours of wrangling on the summit's first day, the leaders agreed that the euro zone's bailout funds should be able to directly boost the capital of struggling banks and said that loans they are planning to help Spain recapitalize its banks wouldn't be ranked above those of private investors in the creditor pecking order—responding to an issue that appeared to cause a negative reaction to Spain's request for up to €100 billion($125 billion) of aid.
 

They said they would examine ways for the bailout funds to help well-performing countries that didn't need full-blown economic adjustment programs like those they insisted on for past bailout recipients Greece, Portugal and Ireland. But after considering the purchase of bonds directly from governments and in the secondary markets, they couldn't agree on specifics. Thomas Wieser, a senior European official, said such countries should be able to benefit by the summer.
 

In a statement issued after the meeting, the leaders said: "We affirm that it is imperative to break the vicious circle between banks and sovereigns."
 

After the announcements, the euro jumped to $1.2586, compared with $1.2444 late Thursday in New York.
 

The measures to help Spain and Italy will be fleshed out by July 9, when finance ministers from the euro zone next meet. The proposal to create "a single supervisory mechanism" would be considered "as a matter of urgency" by the end of 2012, a statement from euro-zone leaders said.
 

The leaders said they would push forward on "a specific and time-bound road map for the achievement of a genuine monetary union" in a report that would go before the next scheduled European summit in October. This road map is likely to include steps toward a "grand bargain" of mutual bond issuance in return for a watertight regime of fiscal discipline that Germany wants—as well as how to move forward toward tighter integration of the region's banking systems.
 

The decisions aimed at helping Spain and Italy followed pressure from Italian Prime Minister Mario Monti, who pushed at the summit for a semi-automatic mechanism that would intervene in the secondary market when the interest rates on bonds from vulnerable countries rise too far above those of Germany. Mr. Monti said afterward that he had pushed for the bond-market interventions though "we have no intention of using them at present."
 

The decision on using the bailout funds to boost bank capital directly is dependent on the creation of the single bank supervisor, the leaders agreed. That suggests Spain will not be immediately able to benefit for the up to €100 billion in aid for its banks that it requested on Monday. However, Mr. Wieser said Spain should eventually be able to use the change to take the loans off its government balance sheet.
 

Since Spain announced its intention to seek help for its banks, investors have expressed concerns that the rescue would bloat Spain's debt further and push existing bondholders down in the creditor pecking order in case there is a future debt restructuring.
 

The decisions came after Germany's Finance Minister Wolfgang Schäuble in an interview with The Wall Street Journal signaled new flexibility on confronting Europe's financial problems, saying Berlin may be willing to move sooner than expected to accept shared liability for euro-zone debt.
 

Mr. Schäuble also said that Germany would support short-term measures to deal with the acute financing problems facing some of the region's governments.
 

He said Berlin could agree to some form of debt sharing among euro-zone governments as soon as Berlin is satisfied the path toward establishing centralized European controls is irreversible.
 

"We have to be sure that a common fiscal policy would be irreversible and well coordinated," he said. "There will be no jointly guaranteed bonds without a common fiscal policy."
 

Mr. Schäuble acknowledged that Europe might have to take short-term action to stop the exodus of private-sector capital from the region's bond markets and said there were a number of instruments that could be used, including direct purchases of government debt by euro-zone bailout funds—the European Financial Stability Facility and the European Stability Mechanism.
 

He said he opposed recent proposals for automatic intervention in bond markets by the bailout funds without a formal government request. But he said countries that are putting in place economic and fiscal reforms but still facing pressure on bond yields could formally request that the bailout funds intervene. Such moves could help renew investor confidence in countries' debt sustainability and bring yields down, Mr. Schäuble suggested.
 

"We can do whatever is possible within the framework of the EU treaties," Mr. Schäuble said, speaking in English in an hour-long interview late Wednesday in his spartan Berlin office.
 

Mr. Schäuble's comments indicate that Germany is more flexible than many observers in Europe have thought after Ms. Merkel told German lawmakers early this week that there wouldn't be full mutualization of European debt in her lifetime. German lawmakers who were present have said that Ms. Merkel's comment was made in jest and that media have exaggerated its significance. Mr. Schäuble's comments seem to support this view.
 

Such a fundamental change—in effect, a grand European bargain between Germany and other euro members—would require countries to give up a large degree of sovereignty over their budgets. Many European policy makers are asking how far Berlin is willing to go in putting its financial strength at the disposal of the euro zone.
 

"We are willing to go as far as we need to in order to get a sustainable agreement in Europe," Mr. Schäuble said.
 

While Berlin continues to insist that European leaders take concrete steps toward a fiscal union, Mr. Schäuble signaled that Germany is open to a level of mutual financial support between euro members that has so far been taboo in the currency bloc's biggest country—under the right conditions.
 

"We cannot separate liability [for public debt] from the competence to decide on fiscal policy. This would be to ignore the most basic lessons of the crisis. As soon as we have a joint EU fiscal policy, we can consider joint liability—the sequencing is key," Mr. Schäuble said.
 

Mr. Schäuble's comments on the timing of a move to some form of common debt issuance are significant because senior German officials have previously suggested that shared liability for debts could happen only in the very long term, after the euro zone has fixed all of its structural flaws.
 

Analysts say a major challenge for establishing common debt issuance would be to shorten or bypass the cumbersome process of amending the EU treaty via the parliaments of all 27 EU member countries, without running into constitutional hurdles in Germany itself.
 

Germany's price for accepting common debt issuance is a euro-zone-wide agreement to transfer control of budgets to the European Commission. Germany's price for accepting common debt issuance is a euro-zone-wide agreement to transfer control of budgets to the European Commission.Mr. Schäuble repeated a call to establish a fiscal-policy commissioner, or budget czar, in Brussels with broad power over countries' finances.
 

Under the German proposal, the new commissioner could strike down national budgets if they weren't in line with monetary-union rules and sanction profligate member states with fines and other measures. Until such controls are agreed, European states cannot be made liable for each other's debts, Mr. Schäuble said.
 

Mr. Schäuble said Germany doesn't believe in the efficacy of throwing more money into a firewall to fight financial contagion. Europe and the International Monetary Fund now have some $2 trillion in resources as a global firewall against financial contagion, Mr. Schäuble said, as he called for ending the discussion over building an even higher firewall.
 

"It does not make sense to open this discussion over and over again," he said. "In the end the firewall can only be the vehicle to give the countries in focus the time to do the necessary reforms and that is what we must aim for."

Source: WSJ /Giada Zampano, Matina Stevis and Daniel Inman contributed to this article.