By GABRIELE STEINHAUSER and GREG KELLER
BRUSSELS (AP) -- Efforts to stabilize Europe's financial crisis were thrown into disarray late Monday as the 17 countries that use the euro braced for a possible downgrade of their credit ratings.
The leaders of France and Germany sought to restore confidence in the troubled European currency during the day with a joint call for changes to the European Union treaty so that countries using the euro would face automatic penalities if budget deficits ran too high.
Stock prices rose and borrowing costs for European governments dropped sharply in response to the changes proposed by French President Nikolas Sarkozy and German Chancellor Angela Merkel. They said their proposals would prevent the kind of out-of-control spending and borrowing that led to the debt crisis that is engulfing Europe and threatening the global financial system.
But on Monday night two people familiar with the matter said Standard & Poor's is examining the credit rating of all 17 eurozone countries for a possible downgrade as the continent's debt crisis lingers. They said S&P is likely to make an announcement on putting the euro countries on "credit watch" after the closing of markets in the U.S. on Monday.
The people were speaking on condition of anonymity because of the sensitivity of the matter.
The threat to downgrade all 17 eurozone countries -- including the ones that enjoy the stellar AAA-rating -- comes ahead of a crucial summit of EU leaders later this week. If there is widespread support at the summit, it is assumed that would be an important first step in bringing an end to the crisis, which has dragged on for more than two years.
"Our wish is to go on a forced march toward re-establishing confidence in the eurozone," Sarkozy said at a news conference in Paris, with Merkel at his side. "We are conscious of the gravity of the situation and of the responsibility that rests on our shoulders."
EU treaty changes could take months, if not years, to implement and don't wipe away the mountains of government debt dragging down Europe's economy. But preliminary buy-in Friday from the 17 countries that use the euro could set the stage for further emergency aid from the European Central Bank, the International Monetary Fund or some combination.
"The onus is still on the ECB to print money to make huge loans or bond purchases and draw a line under the crisis," said Jennifer McKeown, senior European economist at Capital Economics. "Perhaps if other member states sign up to Merkel's and Sarkozy's proposals this week the (ECB) will step in."
Sarkozy pledged to have a revised EU treaty ready for signing by March. It would then need to be ratified in each country, which could mean lengthy parliamentary debates or national referendums in some cases.
"A lot depends on the specifics and how these are going to be framed by lawyers," said Piotr Maciej Kaczynski, an expert on EU constitutional issues at the Center for European Policy Studies in Brussels.
At the very least, it could take at least 18 months to ratify a new treaty once it has been signed by all heads of state, said Kaczynski. "That is a much longer timeline than what markets might want," he said.
Bond-market analysts said they remain skeptical of Europe's ability to prevent future profligacy. "If you say it strong enough and often enough maybe people will believe it," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. "But I don't think the markets believe 'Merkozy' at this point."
EU governments reacted with caution.
No other EU leaders came out against the Franco-German proposals, but no strong statements in favor were immediately forthcoming. The reaction from Austrain Finance Minister Harald Waiglein was fairly typical: "There is nothing here that contradicts our position," although more details are needed, he said.
The modern EU is based on a set of treaties, dating as far back as the 1950s, when the project of consolidating the continent began. The treaties detail the rules that countries must follow and outline the mandates of institutions like the ECB. The most recent was the Lisbon Treaty, which was ratified in 2009, giving additional powers to the European Commission and European Parliament.
Sarkozy said he and Merkel would prefer that the treaty changes they're proposing be agreed to by all 27 members of the EU. But he left the door open to an agreement only among the 17 euro countries and anyone else "who wants to join us."
Sarkozy and Merkel discussed several broad changes for the EU treaty, but failed to provide much detail. The changes they outlined included:
-- Introducing an automatic penalty for any government that allows its deficit to exceed 3 percent of GDP. A majority of nations would need to oppose automatic sanctions for a country to avoid them.
Governments are supposed to abide by the deficit limit under existing rules, but many, including France, have flouted it. Further, punishment only occurs after a majority of euro countries votes to impose them.
-- Requiring countries to enshrine in law a promise to balance their budgets.
A key issue for the proposal's final approval will be how much flexibility countries can have to run temporary deficits during economic downturns.
-- Pledging that any future bailouts would not require private bond investors to absorb a part of the costs, as was the case for the Greek bailout.
Germany had earlier insisted that Europe's permanent bailout fund would demand private investors take losses if a country in the future needs rescuing.
-- Promising to not criticize or otherwise comment on the work of the ECB.
This is intended to ensure the bank's independence and its ability to act without pressure from European leaders.
Sarkozy said more details would be included in a letter sent Wednesday to European Council President Herman Van Rompuy.
After Sarkozy and Merkel spoke, stocks rose and borrowing rates for governments across Europe plunged, indicating a sharp rise in investor confidence in the continent's ability to resolve the crisis.
France's CAC-40 index climbed 1.2 percent, Germany's DAX rose 0.4 percent and markets outside of Europe also pushed higher, with the Dow Jones industrial average up 1.2 percent.
French banks, which have been hit hard this year over fears about their large exposure to the government bonds of financially weak countries like Greece, saw some of the biggest gains.
Societe Generale's stock price climbed 6.2 percent while BNP Paribas rose 4.9 percent. In Italy, shares of Unicredit rose 5.4 percent while Spain's Santander rose 3.6 percent.
Worries about the stability of the euro reached a fever pitch in recent weeks as the yields on Italy's bonds -- in a nutshell, its borrowing costs -- jumped above 7 percent. That is the level that eventually forced Greece, Ireland and Portugal to require bailouts. By comparison, bond yields in Germany, Europe's largest and most stable economy, are roughly 2 percent.
Italian and Spanish bond yields fell sharply on Monday, an indication of growing investor confidence in their financial future. The yield on Italy's benchmark 10-year bond fell from 6.65 percent to 5.93 percent.
Italy, whose government debt is equivalent to 120 percent of the country's annual economic output, needs to refinance $270 billion of its $2.6 trillion of outstanding debt by the end of April.
The size of the problems facing Italy and Spain are considered too large for the existing funds available to the European Financial Stability Facility ($590 billion) and the IMF ($389 billion.) To boost the firepower of the IMF, several economists have proposed that the ECB lend to it.
The big threat to the global financial system is that Europe's debt crisis could spiral out of control.
If governments default on their bonds, banks that own them could take a significant hit. It could become very difficult for these banks to borrow and nervous depositors could flee with their cash. In the worst case, a global financial panic could be triggered, in which banks all over are too skittish to lend to each other. That would cause a credit crunch that deprives businesses of the short-term financing they depend on for day-to-day operations.
With such fears in the air, the United States is ratcheting up its involvement.
Geithner will meet Tuesday in Germany with ECB President Mario Draghi and German Finance Minister Wolfgang Schauble. On Wednesday, he travels to France for talks with Sarkozy and the prime minister-elect of Spain, Mariano Rajoy Brey.
Pan Pylas in London, Sarah DiLorenzo in Paris and Raf Casert in Brussels also contributed to this report.
Copyright 2011 The Associated Press.