Merkel Tempers EU Summit Hopes

By TOM FAIRLESS And RIVA FROYMOVICH

The Wall Street Journal

As investors look toward a Sunday meeting of European leaders for a sweeping solution to Europe's debt crisis, a spokesman for German Chancellor Angela Merkel on Monday warned against hoping that all the euro-zone's debt woes would be resolved by then.

Ms. Merkel's spokesman Steffen Seibert said a package of measures would be agreed on at the European Union summit in Brussels on Sunday, but "the chancellor reminds [everyone] that the dreams that are emerging again, that on Monday everything will be resolved and everything will be over, will again not be fulfilled."

Ms. Merkel—who walks a tightrope in trying to satisfy a domestic audience suspicious of European bailouts while facing demands from the U.S. and other international allies for German action to stem the crisis—has said repeatedly in recent months that solving the euro-zone debt problem will require a long-term process of reforms at the European and national levels, despite the "yearning" of many investors and commentators for a single dramatic announcement that would remedy the situation.

Financial markets' hopes of a breakthrough had risen ahead of Sunday's summit, spurred by the weekend's optimistic remarks from Group of 20 officials. On Monday, the comments from the chancellor's spokesman hit stock markets in Europe and the U.S.—with U.S. shares staging their steepest drop in two weeks.

At the meeting of finance ministers and central bank governors from the G-20 industrial and developing nations over this past weekend, Germany and France said they had agreed on the broad outlines of a package. The agreement between Europe's two biggest economies was expected to set the stage for a European agreement on resolving Greece's debt woes, creating a powerful bailout mechanism, and shoring up European banks against sovereign default.

The EU faces resistance from banks over plans for larger write-downs on Greek government debt and a forced recapitalization of banks. The European Commission last week outlined proposals to shore up European banks in the face of the escalating debt crisis. Those with inadequate capital will need to raise it from private sources or the government, the commission said.

German Finance Minister Wolfgang Schäuble said on Monday that he expects EU leaders to agree on new measures to combat market uncertainty at the coming summit—including a higher capital ratio for the 91 European banks that were stress tested in July. Mr. Schäuble, at a conference in Düsseldorf, said he assumes EU leaders will agree to a Tier 1 capital ratio—the ratio of a bank's core equity capital to its total risk-weighted assets—of 9% for the stress-tested banks. This summer's stress tests set the threshold at 5%.

But Mr. Schäuble, too, cautioned that the summit is unlikely to produce a permanent solution to the debt crisis.

Although Paris and Berlin stressed that details on each of these points still needed to be worked out and that the deadline for a comprehensive plan is the Cannes summit of G-20 leaders in early November, the cautious comments by Ms. Merkel's spokesman disappointed financial markets.

Mr. Seibert said the German chancellor considers what has been achieved so far as "important steps on a long journey, a journey that will certainly continue well into next year."

Mr. Schäuble nevertheless warned that the euro zone's debt crisis must be resolved quickly to reduce the impact on Germany's economy. "We need a durable solution for Greece," which will involve a reduction of Greece's debt, Mr. Schäuble said. However, some measures to resolve the crisis, including changes to the EU's treaties, will take longer to resolve, he said.

Germany's constitutional "debt brake" is important for the stability of the euro zone, and a similar agreement is needed at a European level, the finance minister added. Germany's "debt brake" law forces the federal and state governments to virtually eliminate their structural budget deficits over the next five to ten years.

Separately, European Council President Herman Van Rompuy, who will preside over Sunday's meeting of leaders from the 27-nation EU, said European leaders are working on the comprehensive package discussed by officials last weekend.

"For weeks the commission and I have already been working on a comprehensive package to create more confidence in the financial sector and in the sovereign bonds of countries under pressure," he said.

José Manuel Barroso, president of the European Commission, the EU's executive branch, lifted expectations for Sunday's meeting despite Berlin's warning for caution. "I believe the European Council of this weekend will be critically important," Mr. Barroso said.

Messrs. Van Rompuy and Barroso said euro-zone nations with high debt burdens can't walk away from austerity efforts and other overhauls to reduce the imbalances between the stronger and weaker economies in Europe.

However, Mr. Van Rompuy said there is a need for "growth-friendly" austerity in the EU and that efforts to direct EU economic assistance towards troubled economies are important.

Mr. Barroso reiterated his call for a tax on financial transactions, also saying "we need growth in Europe."

The commission isn't seeking to punish banks, Mr. Barroso said, and it wants a strong financial sector in the EU. But he accused banks of behaving irresponsibly in the past and said some of the financial sector's behavior was of a "criminal nature."

—Laurence Norman contributed to this article.

Write to Tom Fairless at tom.fairless@dowjones.com and Riva Froymovich at riva.froymovich@dowjones.com