Tensions are building up in the Eurozone as France, Germany Clash Over Proposal to Bail Out Banks.

France and Germany clashed over whether to create a fund to bail out banks pounded by the global credit crunch, kicking off a European version of the debate that has been raging in the U.S. for two weeks.

French Finance Minister Christine Lagarde told the German newspaper Handelsblatt in an interview to be published today that a “rescue package” was needed to help “smaller” European states “threatened with a banking failure.” Germany opposed the proposal, with finance ministry spokesman Torsten Albig saying his government “doesn’t support the plan.”

The conflict between the two biggest euro-region economies undermined efforts to build a consensus European response to the financial crisis as a recession looms. Other fissures emerged, as Ireland’s decision to guarantee bank deposits and debts prompted criticism by British bankers yesterday that it “distorted competition.”

A European version of the Paulson plan is a “non-starter” because of competing agendas and coordination difficulties, Klaus Baader, chief European economist at Merrill Lynch and Co. in London, said in a Sept. 29 report. Still, he expects increased cooperation among governments confronting the crisis.

French President Nicolas Sarkozy may propose the bailout fund at an Oct. 4 meeting that Luxembourg Prime Minister Jean- Claude Juncker said he’s attending with leaders of Great Britain, Italy and Germany, as well as European Central Bank President Jean-Claude Trichet.

The proposed fund would total 300 billion euros ($420 billion), Reuters reported, citing an unidentified European government official.

The specifics of a coordinated plan notwithstanding, Germany rejects a Europe-wide approach to bank rescues, said Albig, the finance ministry spokesman.

“The idea of applying one solution, one big bang” should the banking crisis spread “is not practicable and would create new, enormous problems,” he told reporters yesterday in Berlin. “The tailor-made solution is the right way.”

Current State Of Affairs

Nonetheless, being the eternal optimist that I am, I remain heartened by Paulson’s assurances that “the banking system is sound”.

Mike “Mish” Shedlock
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