(Reuters) - Treasury Secretary Timothy Geithner threw his weight on Tuesday behind a Franco-German plan to tackle the euro zone's sovereign debt crisis and said the European Central Bank had to play a major role in any solution.
Geithner offered his support after Standard & Poor's agency fired a second warning shot at the bloc in 24 hours by threatening to cut the credit rating of its rescue fund.
German Chancellor Angela Merkel and French President Nicolas Sarkozy want to change the EU treaty to impose mandatory penalties on euro zone states that exceed deficit targets, aiming to restore market trust and prevent the crisis spiraling out of control.
Geithner said he was encouraged by moves towards "fiscal union" - under which euro zone states would obey a common set of tight budget rules - and stressed the central role in tackling the crisis of the ECB, which has been reluctant to take decisive steps until governments get to grips with their budget problems.
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Speaking after talks in Berlin with German Finance Minister Wolfgang Schaeuble, Geithner said euro zone countries needed reforms to lay the foundations for the economic growth which is essential if Europe is to solve its debt problems.
He also called for "reforms to create the architecture of fiscal union to make monetary union more viable for the long run". Likewise, governments and central banks needed to offer financial support to protect the European financial system and allow states to borrow at sustainable interest rates.
"The ECB has been playing a central role in this crisis. It's obviously going to continue to do that. Of course ultimately, these things only get solved by governments and central banks doing what's necessary, but their rules are different," Geithner said.
He also met ECB President Mario Draghi in Frankfurt before an EU summit in Brussels on Thursday and Friday, a sign that Washington shares the view that the event may be a decisive moment for the global economy.
Geithner will also meet the leaders of France, Italy, Spain, and EU institutions to press for decisive action.
Draghi has signaled that a euro zone "fiscal compact" could encourage the ECB to act more decisively. It has been reluctant to buy up debt from distressed euro states more aggressively, arguing that doing so would take pressure off governments to fix their finances.
CONTINUING DISAGREEMENTS
A few hours after Sarkozy and Merkel announced they would put their plan involving changes to the EU treaty to the Brussels summit, Standard and Poor's put the credit ratings of 15 countries, including Germany and France, on review late on Monday for a downgrade by one to two notches.
The U.S.-based agency cited "continuing disagreements among European policy makers on how to tackle the immediate market confidence crisis".
S&P went a step further on Tuesday, placing the top-notch rating of the euro zone's 440 billion euro rescue fund, the European Financial Stability Facility (EFSF), on negative watch since it depends on the creditworthiness of the currency bloc's six AAA-rated countries.
European Council President Herman Van Rompuy, who will chair the summit of the 27-nation European Union this week, proposed giving a bigger, permanent euro zone rescue mechanism the status of a bank that would allow it to access ECB funding.
Germany has so far opposed any such move, which it says would breach a treaty ban on the ECB financing governments.
Van Rompuy said tighter budget oversight sought by Paris and Berlin for the 17-nation euro area could be achieved quickly with only minor tweaks to the EU treaty, that might not require full ratification procedures in many countries.
"To restore market confidence in the euro area, and to ensure the political sustainability of solidarity mechanisms, it is crucial to enhance the credibility of our budget rules (deficit and debt levels) and to ensure full compliance," he wrote in a report to EU leaders obtained by Reuters.
He also said the issuance of joint euro zone bonds should be a long-term objective, challenging another German red line in a text likely to be the object of heated negotiations.
S&P warned of slowing economic growth amid so much austerity, predicting a 40 percent chance of a fall in euro zone output. A downgrade could automatically require some investment funds to sell bonds of affected states, making those countries' borrowing costs rise still further.
Merkel brushed off the S & P threat, saying: "What a ratings agency does is its own responsibility." Her finance minister, Wolfgang Schaeuble, said the wake-up call was S&P's way of urging European leaders to act.
But Jean-Claude Juncker, chairman of euro zone finance ministers, said he was astonished by S&P's announcement, which he called "a wild exaggeration and also unfair" because it failed to take account of Italy's new austerity plan.
In Paris, Sarkozy's office said S&P had taken its decision last Tuesday, before both the Italian budget and the Franco-German plan for stricter budget rules.
SPANISH BOOST
Sarkozy and Merkel say they want treaty changes to be agreed in March and ratified after France wraps up presidential and legislative elections in June.
They won a boost on Tuesday when incoming Spanish Prime Minister Mariano Rajoy said he would support a new treaty. Although not yet in office, Rajoy is expected to meet Merkel and Sarkozy and outline his policies at a congress of European conservative leaders in Marseille on Thursday.
However, some other EU governments, notably Britain, Ireland and the Netherlands, are reluctant to amend the EU treaty, either due to euroskeptics at home or because they fear losing possible referendums on ratification.
British Prime Minister David Cameron, under pressure from the euroskeptic wing of his Conservative party, said he would demand safeguards, such as ensuring the EU's market is not distorted by closer cooperation between euro zone countries.
"Euro zone countries do need to come together, do need to do more things together," he told BBC TV. "If they choose to use the European treaty to do that, Britain will be insisting on some safeguards too. And as long as we get those, then that treaty can go ahead. If we can't get those, it won't."
However, Merkel and Sarkozy said that if countries such as euro outsider Britain blocked a treaty change for all 27 EU members, the 17 states that use the common currency could proceed with an agreement on their own.
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