France to Defend Credit Rating After Moody’s Warning

Officials are working on the broad outlines of a three-pronged agreement to keep the debt crisis from spiraling into Europe’s large countries.

They have been giving serious consideration to increasing the size of a new euro zone bailout fund of 440 billion euros to at least 1 trillion to 1.5 trillion euros (about $1.3 trillion to $2.06 trillion), an idea pushed by the United States Treasury secretary, Timothy F. Geithner, who argues that similar action helped stem the financial crisis that started on Wall Street in 2008.

Europeans are also discussing recapitalizing many European banks as insurance in case the crisis worsens; as well as forcing banks to take sizable losses on their holdings of Greek debt to help the country get back on its feet.

The discussions have taken on greater urgency since Moody’s warned late Monday of a possible downgrade to France’s flawless credit rating. French finance officials worry that any such move would make it hard for Paris to negotiate solutions, according to an official who was not authorized to discuss the situation publicly.

The rally in American stock markets was set off by a report late Tuesday on the Web site of The Guardian, a British newspaper, that France and Germany had agreed to increase the size of the rescue fund — the European Financial Stability Facility — to as much as 2 trillion euros to contain the crisis and backstop Europe’s banks. But almost as soon as those hopes soared, European officials quickly brought them back to earth, with denials flooding forth from Brussels, Paris and Berlin.

This latest round of rumors and rebuttals about a European solution was a repeat of earlier situations.. Such episodes have played out several times since the debt crisis intensified this year. Most recently, investors have been pegging hopes on a meeting of Europe’s leaders set for this coming Sunday in Brussels, anticipating that a comprehensive solution to the debt crisis might be unveiled.

Fueling those hopes had been impressions given last weekend in Paris, at a meeting of finance ministers from the Group of 20, that a grand plan was forthcoming. Those conveying such signals included the French finance minister, François Baroin.

Mr. Geithner said at the Paris meeting that he was encouraged by the speed and strategy of the European planning, but said the Europeans still had a lot of work to do on the fine print. “As you know it’s all in the details, and it’s very hard to judge the impact something will have until you see it take shape,” he said.

And on Monday, Chancellor Angela Merkel of Germany quickly brought things back to reality, warning that “dreams” of a package that would immediately resolve the problems were unrealistic.

Eventually, whether this coming weekend or sometime after, European leaders will almost certainly come forward with some form of solution that they hope will convince investors that they have the wherewithal to keep the crisis from infecting Spain and Italy, the third- and fourth-largest economies in the euro monetary union. That is the foremost goal of all their efforts.

But should the leaders fail to devise a convincing enough plan, there is widespread fear the borrowing costs for both of those countries will rise so high that the governments will be shut out of borrowing in international markets — the same way Greece, Ireland and Portugal were before they had to be bailed out. The overriding worry, though, is that there may not be enough money to bail out Italy and Spain, or to keep the contagion from spreading even farther.

Finance officials want to have something in place before their bosses — the presidents and prime ministers of the Group of 20 industrialized nations — gather Nov. 3 and 4 in Cannes, France, to discuss the economic and financial problems that now plague both the European and American economies.

But even if a deal on the bailout fund is agreed to, any stock market rally might not prove to be permanent, as the realization sank in that the costs could weigh heavily on certain countries for some time to come. That was the case in the autumn of 2008, when American officials struggled to contain the fallout from the demise of Lehman Brothers. Back then, a number of market relief rallies were followed by a continuing decline in stocks.

A fresh reminder of the current crisis’s contagion dangers came on Tuesday, when France rushed to defend its AAA credit rating — one of the few top ratings left among major Western economies — after a warning by Moody’s Investors Service that the French government was at risk from the Continent’s widening sovereign debt problems. Mr. Baroin was compelled to go on French television Tuesday to declare the government would “do everything to avoid being downgraded.”

The price that France pays to borrow on international financial markets compared with Germany surged on Tuesday to its highest level since the euro was introduced in 1999. Rising borrowing costs are what pushed weaker countries, including Greece, Ireland and Portugal, to seek bailouts.

More problems in Italy or Spain would stretch the finances of big countries like France and Germany even further.

While France’s accounts are still in better shape than those of many of its neighbors, they could deteriorate if the government provided significant financing to other European countries or to its own banking system in a bid to keep the euro crisis from spiraling. Such moves could give rise to significant new liabilities for the government’s balance sheet, Moody’s warned.

President Nicolas Sarkozy has made it a priority to keep France’s top rating intact, especially headed into a campaign against his Socialist opponent, François Hollande — who, like Mr. Sarkozy, has vowed to cut France’s deficit to 3 percent of gross domestic product by 2013.

Stephen Castle contributed reporting from Brussels, and Louise Story from New York.

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