The eurozone again found itself in crisis overnight, as investors despaired that a solution for the roiling Greek debt crisis would be found at this week’s emergency meeting of European political leaders.

Borrowing costs for Spain and Italy moved higher overnight, with Italian 10-year bond yields climbing above 6% to close at their highest level since 1997. Spanish 10-year bond yields finished at 6.39%, a rise of one percentage point since the beginning of the month. European bank shares also tumbled as investors worried that the European bank “stress tests”, released last Friday, failed to consider the impact of a Greek debt default.

Leaders of the seventeen eurozone countries will hold an emergency summit in Brussels on Thursday to discuss the Greek debt crisis, but they remain deeply divided on the best way forward.

On Friday, German Chancellor Angela Merkel dismayed investors when she said that “it’s not a meeting in itself that will help Greece, but a new program”. On Monday, her spokesman tried to strike a more optimistic note, saying that the German government would be working hard to ensure that Thursday’s meeting produces a good outcome “which will send a strong and clear signal to the markets”. He added “it’s because she believes that this is possible that the Chancellor is preparing her trip to Brussels”.

At this stage, the only thing that eurozone leaders can agree on is that all previous attempts to rescue Greece have failed. The Greek economy is in crisis, and the country’s debt now stands at an insupportable 150% of GDP. As a result, eurozone officials are increasingly looking at ways to cut Greece’s debt burden.

According to the German publication Der Spiegel, Germany’s finance ministry is looking at various ways to cut Greece’s debt by about €70 billion ($US99 billion), which would leave it at a more tolerable level of about 120% of GDP.

One possibility would be for Europe’s bailout fund, the European Financial Stability Facility, to buy back Greek bonds from private sector holders, such as banks and insurance companies. Alternatively, the EFSF could lend Greece money so that it can buy back its own bonds. Because Greece’s debt is trading at less than half its face value, a buy-back of Greek debt would substantially reduce Greece’s debt burden. And the private sector would participate in this program by agreeing to sell Greek bonds at well below their face value.

Another plan under consideration is for holders of Greek bonds to swap them for eurobonds, debt backed by the entire euro region. But markets are uncertain that these plans have the Merkel’s backing. In an interview on German television on Sunday, Merkel said that she was looking at plans to cut Greek debt “with scepticism”, but did not indicate that she fundamentally opposed the approach. A restructuring, she pointed out, “would have a negative effect” if a country stopped making the necessary effort to improve its budgetary situation.

Meanwhile, Bundesbank chief Jens Weidmann, who was a former adviser to Angel Merkel, also expressed his strong reservations about about issuing eurobonds in an interview with the German publication Bild-Zeitung. “Nothing would destroy the incentives for a solid fiscal policy more rapidly and more permanently than joint liability for the state’s debt,” he said.

At the same time, financial markets remain painfully aware that any rescue plan for Greece that requires the participation of private sector creditors could prompt the ratings agencies to declare an event of default.

Overnight, European Central Bank chief Jean-Claude Trichet again warned the ECB would not accept bonds issued by countries in default. Given that Greek banks are heavily dependent on the ECB for funding, this could lead to a collapse of the Greek banking system. The fear is that it would also trigger a broader crisis in the European financial system.

*This article first appeared on Business Spectator