German Chancellor Angela Merkel sought to bury once and for all the idea of common euro zone bonds. She said that Europe would not share total debt liability "as long as I live".
The EU's big four finance ministers met this evening to narrow differences on how to solve a worsening debt crisis.
Two days before a crucial EU summit, European Council President Herman Van Rompuy released a seven-page report on closer fiscal and banking union.
The report envisaged a euro zone treasury that would issue common debt in the medium term.
Merkel immediately stamped on the idea of mutualising debt, favoured by France, Italy and Spain, at a meeting in Berlin according to sources.
"I don't see total debt liability as long as I live," she was quoted as saying, a day after branding the idea of euro bonds "economically wrong and counterproductive".
However Germany, the EU's biggest economy and paymaster, appeared ready to budge on using the euro zone's rescue funds more flexibly to help banks and reassure investors spooked by an increased risk of facing write-downs on government bonds.
The parties in Merkel's centre-right coalition proposed allowing the European Stability Mechanism (ESM), to funnel aid directly to national bank rescue funds, according to a draft seen by Reuters.
Direct aid to bank could aid bailout countries
That could spare governments like Spain's some of the political stigma of a bailout, although the loans would still be on the state's balance sheet, increasing its debt, and would still be subject to strict conditions.
More significantly, conservative floor leader Volker Kauder told another meeting of lawmakers that euro zone governments were discussing making it possible to remove preferred creditor status from the ESM rescue fund, participants said.
Neither Merkel nor Finance Minister Wolfgang Schaeuble, who insisted on that treaty clause to make private bondholders take first losses in any future debt restructuring by bailed-out states, spoke out in favour of such a move, the sources said.
The provision has scared investors off buying Spanish debt since Madrid was promised a bailout of up to €100 billion for its debt-stricken banks, since they fear a possible "haircut", driving bond yields up to alarm levels.
Political tensions were already rising before word emerged of Merkel's dismissive comments.
Italian Prime Minister Mario Monti told parliament he would not just rubber stamp conclusions of the EU summit on Thursday and Friday and was ready to go on negotiating into Sunday evening if necessary to agree on measures to calm markets.
Cyprus says no bailout figure mentioned
Cyprus rejected reported bailout figures of €10 billion, saying that no amount had yet been determined and would be determined after talks with the EU.
"Neither ourselves or the people we are talking to have raised the question of the amount," Finance Minister Vassos Shiarly told reporters. "This is a matter which will be determined during the process which will follow. No amount has ever been discussed."
Cyprus, the 17-nation currency area's third smallest economy with just 1 million residents, applied for rescue loans on Monday.
Cyprus needs to plug a €1.8 billion capital shortfall in its second largest lender by June 30. Potential aid could be more comprehensive to cover fiscal requirements, Finance Minister Vassos Shiarly said.
Nicosia takes over the EU presidency for six months on July 1. But in Frankfurt, an ECB spokesman said that a downgrade of the Cyprus credit rating into speculative grade territory by all accepted rating agencies meant that Cypriot government securities no longer fulfilled the creditworthiness requirement.
This means banks cannot offer Cyprus government bonds in return for cash loans from the ECB. Nicosia is believed to have applied to the EU for aid after exhausting attempts to secure loans from either China or Russia, a close ally, in an apparent effort to avoid the tough conditions and intrusive monitoring of an EU/IMF programme.
On Monday, Spain formally requested up to 100 billion euros in rescue loans to recapitalise a banking sector that is weighed down by bad loans from a burst real estate bubble.
It is seeking to avoid the political humiliation and partial loss of sovereignty involved in a full state bailout programme of the kind granted to Greece, Ireland and Portugal, even though the IMF and EU authorities will still have to monitor the aid.
Spanish and Italian bond yields rose again on Tuesday as scepticism set in before the EU summit. Spain had to pay the highest yields since last November to sell €3.08 billion euros in short-term debt as demand from its ailing banks dwindled.
US calls for progress on crisis
The United States pressed European Union leaders for more steps to stabilize the economy at the summit, and called for further action to stimulate growth in the euro area.
"We believe the Europeans have the capacity to resolve this crisis," White House spokesman Jay Carney said.
