BRUSSELS (Reuters) - It was billed as a summit to save the euro. It may be remembered as the day Europe lost patience with Britain, as most of the continent threw its lot in with EU founding members France and Germany and committed to binding their economies ever more tightly.
There was plenty of talk of history in the making in the week before the Dec 8/9 gathering of European Union leaders - the eighth this year. But it was all about the currency and whether it would survive the strains of a debt crisis that over the past two years has engulfed Greece, spread to Ireland, Portugal, Spain and Italy and now threatens France and even mighty Germany.
As the summit began, there was no hint of the drama that was to come in the early hours of Friday, the moment when Europe split, 26 against one, after about 10 hours of talks. Britain has always had an uneasy relationship with its EU partners, choosing not to join the single currency or sign the open borders Schengen treaty and often kicking against what it sees as Brussels "interference."
But this was a low point. The first time in 39 years that a British prime minister had used a veto to block an EU agreement. David Cameron cast it is a bold and necessary decision to protect British interests. Most of the rest of Europe appeared to regard it as reckless and went a different way. Hours later, when the leaders briefly reconvened to finish their discussions, Cameron cut a lonely figure. French President Nicolas Sarkozy appeared to avoid an extended hand as Cameron walked to his seat.
The build up to this last summit of the year had been much like the previous seven. The language had been recognizable too, even if market pressures had added an unprecedented degree of urgency to glacial EU decision making. Overnight borrowing from the European Central Bank hit its highest level since March at the start of December, showing the degree of tension amongst banks.
PROFOUND CONCERN
U.S. Treasury Secretary Timothy Geithner had spent several days in Europe before the summit. The United States, like all of Europe's trade partners, had been watching the accelerating debt crisis with profound concern, worried for their own economies and banks.
In meetings with the head of the ECB, Mario Draghi, and euro zone finance ministers the conversation was all about the two-year-old debt crisis and how to resolve it. The issues: the role of the ECB, how far should or would it stand behind countries to buy them breathing space, the scale of the euro zone's rescue fund, the part to be played by the IMF, and should the EU let private bondholders off the hook.
Geithner spent time in Frankfurt, Berlin, Paris, Marseille and Milan. London didn't figure on his itinerary. During the same week, German Chancellor Angela Merkel and Sarkozy spoke frequently and met in person. There were contacts with Spain's incoming Prime Minister Mariano Rajoy. Draghi was closely involved in discussions at all stages, insiders say. Once more, Cameron was peripheral.
Immediately before the summit, the U.S. assessment of Europe's progress was, in broad terms, they know what they need to do but they need to work out how they're going to do it. As one U.S. official put it, fixing the flaws of the 13-year-old single currency - a monetary union without coordinated budget policy - could not happen overnight. But the Europeans were moving closer to addressing the problem at its root.
That assessment captured well the mood in the hours heading into the latest in a long line of "crunch" summits.
Germany - Europe's biggest economy - was intent on changing the European Union's treaty to enshrine stricter budget discipline and penalties for countries that failed to adhere to them, to ensure there could be no repeat of the current crisis. From the German perspective, only by reforming economies, cutting social benefits and working longer would the indebted members of the euro zone and the single currency project itself emerge from the turmoil. Printing money would buy only a temporary respite and would remove the incentive to reform.
France was ready to back Germany in a push for full-blown treaty change, but really favored the idea of an intergovernmental treaty - akin to a sideline agreement - among the 17 euro zone members, anchoring the single currency and its members at the heart of a new Europe.
NATIVITY PLAY
Britain's prime minister, under pressure from a sizeable anti-EU element in his own party, set off for the Brussels meeting straight from his son's school nativity play, having promised during a particularly raucous session of parliament the previous day that he would defend Britain's interests at the summit.
With hindsight, the choreography on the evening of Thursday, Dec 8 probably should have been clear to Cameron and everyone else.
Speaking a few hours before the summit began, European Commission President Jose Manuel Barroso issued this challenge to Europe's leaders: "What I expect from all heads of governments is that they don't come saying what they cannot do but what they will do for Europe."
Luxembourg Prime Minister Jean-Claude Juncker, who chairs euro zone finance ministers' meetings, was the first to arrive at the Brussels venue. Juncker said he preferred to see unanimity on treaty change among the 27, but if that wasn't possible, the 17 members of the euro zone would have to go it alone. "Their relationship is more intimate than between the 27."
When Cameron arrived in Brussels Thursday it was after 6 p.m.. His first meeting was with Italy's new Prime Minister Mario Monti, an unelected "technocrat" charged with getting Italy's finances in order. Europe's fourth biggest economy has a debt to GDP ratio of 120 percent after years of stagnation under Silvio Berlusconi. The meeting was brief and was followed by 45 minutes of talks with Merkel and Sarkozy. Cameron was accompanied at that meeting by Foreign Secretary William Hague and Jon Cunliffe, the prime minister's most senior EU adviser, the architect of the rules that helped keep Britain out of the euro and Britain's next ambassador to the EU. One official who saw the three leaders emerge said they were "visibly tense."
BRITAIN'S ISOLATION
Then came dinner and the start of the meeting that was to end in Britain's isolation. Sources involved described how events unfolded. The intention was to get the 27 leaders to agree on what they wanted for a stronger euro zone first, and then work out how to achieve it, officials said. It was disagreement over the means, not the objective, that led to the break down.
An official present at the negotiations said Cameron had begun by saying that he understood there was a desire for treaty change, and that he wanted it too, but if Britain were to give its backing, it needed something in return. "His reasoning appeared to be: 'you want treaty change, I want treaty change', 'I need something because you are asking for something'," the official said, describing it as logic that wasn't going to fly.
At that point, the British prime minister set out two concessions he wanted in exchange for Britain's support on treaty change. "One was a safeguard on the internal market ... but that was not the problem," the official said. "Then he launched the idea on financial services."
Financial services account for about 10 percent of Britain's economy and the government has been at pains to shield the sector from regulation emanating in Brussels. Britain had shared the outlines of its thinking with some of its partners, officials said, but it hadn't circulated anything approaching a document sufficiently detailed to form the basis of discussion. For that reason, the demands were news to many of the people around the table. But it wasn't just the way Cameron went about it, it was the substance of the demands. He was effectively asking for a softening of regulation on Britain's financial sector at a time when many voters and politicians believe banks are largely to blame for the crisis Europe is suffering and want tighter regulation on the sector.
DEAD FROM THE START
"Politically speaking, when the banks are considered the enemy and the root of all the problems we have today, Cameron's arguments were the wrong arguments at the wrong time for the wrong people," the official said. "Politically, he was dead from the start."
At that point old enmities came into play, rooted in a widely-held French view that Britain never really belonged in the European Union in the first place. "The French were using all this as a really perfect alibi to get rid of the British. Sarkozy used the proposals of the British to justify an intergovernmental treaty," the official said, explaining that intentionally or otherwise, Cameron had played straight into Sarkozy's hands.
It may have appeared things couldn't get worse for the British prime minister, a relative novice on the EU stage.
"It took 10 or 20 minutes to see that most of the participants were not pleased at all with the idea of Britain getting an opt out or exceptional treatment for their financial services and it didn't fly at all. There was no understanding for it. David Cameron obtained nothing. Just nothing."
"We understand his domestic political situation. He is a prisoner of domestic constraints."
Another official present at the talks recalled the moment, in the early hours of Friday, when European Union President Herman Van Rompuy, who chaired the meeting, proposed moving forward with an intergovernmental agreement of the 17 euro zone nations, with an open invitation for other countries to join.
"France said yes, immediately followed by Germany and then one by one, in a matter of seconds the member states of the euro zone backed the Franco-German call. Within a few minutes, the non-euro zone member states decided they wanted to be in and left Cameron completely isolated. The swing was very, very quick. Everybody was on board in a matter of minutes. I think it was obvious inside the room that Cameron was shocked by the swiftness with which his allies left him alone."
"Cameron made a serious miscalculation. He genuinely thought he could get something back in return and underestimated the willingness of the euro zone to move on. That's our view. This deal has probably saved the euro, but all this will now have serious repercussions on the relationship between Britain and the EU." (additional reporting by Matt Falloon and Mark John in Brussels, Paul Carrel in Frankfurt, David Lawder in Washington; writing by Janet McBride; editing by David Stamp)
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