Your Complete Guide To This Weekend's Huge EU Summit

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Photo: George Eastman via Flickr

rumours are flying and everyone’s looking ahead to a big meeting of eurozone leaders in Brussels on Sunday.There are lots of reports circulating about the kind of solution — if any — leaders will be able to come up with to fix the escalating sovereign debt and banking problems in the eurozone.

So we take a look at some of the ideas being bandied about right now and the likelihood of seeing them come to fruition.

Levering the European Financial Stability Facility

Finally approved after months of bickering, the EFSF is being painted as the saviour of Europe by EU politicians and the press.

But it's becoming clear that the rescue fund simply doesn't have the cash resources to prevent contagion from spreading to Italy and Spain, at least under the terms negotiated back in July.

Levering the EFSF would be one way to expand the resources available to bail out Europe, and there are a bunch of different plans floating around.

Using the EFSF to guarantee first losses to bondholders.

France and Germany are rumoured to have agreed upon a plan to lever the EFSF by insuring first losses on up to €2 trillion ($2.8 trillion) in sovereign bonds of Italy and Spain.

EU leaders fear that borrowing costs will spiral out of control in these countries, inhibiting their ability to pay off their debts and threatening solvency. Italy and Spain would be far too large for other eurozone countries to rescue, and a default there could jeopardize the solvency of the euro area as a whole.

Notably, this would NOT require a new round of parliamentary approvals in eurozone nations. But there are also some doubts that this plan would actually work, particularly at the EFSF's current size.

Turning the EFSF into a bank and pumping cash into it from the European Central Bank.

This plan, too, would expand the firepower of the EFSF, making it a far more effective tool. Such a plan would balloon the EFSF's cash resources.

It's also not likely to happen -- at least not anytime soon.

According to Dow Jones, EU leaders have already ruled out a solution involving ECB funding and that's not surprising. Members of the ECB have opposed such a plan on the grounds that the central bank is prohibited from funding governments by EU law.

An ECB legal opinion on a similar institution (the permanent European Stability Mechanism set to replace the EFSF in a few years) already made clear this year that such an arrangement violated EU law (via FT). The FT also reports that Germany has been particularly vehement in upholding that legal provision.

Regardless of how well such a solution would fix the problem, it's just not going to be on the table at this point.

Increased private sector involvement (PSI) in losses on Greek debt.

Private sector Greek bondholders have been freaking out about the possibility that they'll have to make even larger write downs on their Greek bonds than they previously expected.

All the chatter has been about a 30-50% haircut lately, compared to the 21% predicted when EU leaders reached an agreement on a second bailout in July.

Bigger PSI is almost certain to be a resolution that comes out of their summit this weekend. There are some good reasons for this, particularly that it makes Greek debt more sustainable in the long term.

But there are even more frightening short term problems. Essentially, bigger haircuts will necessitate bank recapitalization. The funding problems that led to Brussels-based bank Dexia's fall earlier this month were largely brought about by their writedowns on Greek debt. With bigger haircuts (and without significant bank recapitalization), more banks are almost certain to follow.

Bank recapitalizations

Bank recapitalizations have been the subject of investor fervor over the last few weeks, as they would bolster confidence in the banking sector.

EU leaders have already announced that some kind of bank recapitalization is imminent, but it's unclear to what extent banks will need to raise funds by themselves or if/when national governments and even the EFSF would step in.

The plan likely to surface is bound to be two-tier: some banks are going to be able to borrow EU funds and others are not. If this is not done well, we can expect to see traders wage speculative attacks on certain banks.

EU treaty changes

German Chancellor Angela Merkel and French President Nicolas Sarkozy advertised that changes to the treaties that govern the EU could be forthcoming.

Hopes that these changes could prevent a recurrence of the current crisis and/or provide a fix to the euro area's current drama have been muted by the political realities we've seen since trouble started 18 months ago. It took nearly three months for all 17 eurozone countries to approve a plan to expand the EFSF, and even longer for them to decide to talk about a second Greek bailout.

Treaty changes may be forthcoming eventually, but it is almost impossible that any changes would affect the crisis in the short term.

A financial transaction tax

We're bound to see more talk about a financial transaction tax, but don't get too worried anytime soon.

Despite Merkel's and Sarkozy's professed commitment to imposing a tax on financial transactions -- and apparent interest about it from EU leaders -- the flack they'll receive about such a plan will be overwhelming. Also, this would likely occur under the umbrella of the EU as a whole (not just the eurozone) and the U.K. has already come out staunchly opposing it.

That annoying €8 billion ($11 billion) in troika aid

This is virtually approved already, given the positive report that came from EC/ECB/IMF inspectors earlier this month, but there's still bound to be some talk about the wisdom of disbursing it.

But don't be fooled -- unless everyone wants Greece to see a disorderly default in the future, the euro area has to give it more money, and no one's about to turn down extra cash they don't have to fight about.

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