By Jan Strupczewski and Ingrid Melander
BRUSSELS/ATHENS (Reuters) - The head of the International Monetary Fund criticized Europe's piecemeal response to the euro zone debt crisis on Tuesday after Germany and other states resisted his calls for firmer action.
IMF Managing Director Dominique Strauss-Kahn failed to persuade finance ministers of the 16-nation single currency area on Monday to increase the size of their financial safety net or the European Central Bank to step up government bond purchases.
"The euro zone has to provide a comprehensive solution to this problem," Strauss-Kahn told reporters after meeting Greek Prime Minister George Papandreou in Athens. "The piecemeal approach is not a good one.
Tension persisted on European bond markets after euro zone ministers said they would take no new measures to tackle the risk of contagion spreading from Greece and Ireland, which have got EU/IMF bailouts, to Portugal and perhaps Spain and Italy.
Some central bankers and market participants say it would have been better to have put Portugal protectively under the EU/IMF financial umbrella last week at the same time as Ireland rather than dealing with one country after another.
EU finance ministers did agree on Tuesday to conduct a new round of more rigorous bank stress tests in February after doubts about last July's first pan-European examination of their ability to withstand financial shocks sapped market confidence.
EU Monetary Affairs Commissioner Olli Rehn said the new survey would be based on new financial architecture after just seven out of 91 European banks failed the previous health check.
"We need to opt for fullest possible transparency when conducting the bank stress test," he told a news conference.
EU paymaster Germany took the lead in arguing the existing safety net was sufficient, and ministers said they had not even broached a proposal for issuing joint bonds, opposed by Berlin.
The premium investors demand to hold the bonds of Portugal and Spain rose in response to the ministers' inaction. Traders said the ECB, which engineered a fall in both countries' borrowing costs last week by stepping up its purchases of government debt, was staying on the sidelines.
"Ministers left the ball with the ECB," said Carsten Brzeski, senior economist at ING in Brussels. "Currently, the ECB is buying time for politicians. However, the ECB will not want to remain the only crisis manager and is eager to play the ball back to politicians."
An ECB source, speaking on condition of anonymity, said the central bank did not want to take on all the risk of supporting euro zone debtors by massive bond-buying, and wanted governments to take additional measures such as increasing the rescue fund.
Luxembourg Finance Minister Luc Frieden summed up the ministers' approach, telling Reuters Insider television: "We have all the tools to make sure that despite the temporary turbulence, financial markets should understand that there is no major risk for the stability of the euro zone."
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The European Financial Stability Facility (EFSF) has the capacity to issue bonds worth up to 440 billion euros to help out troubled euro zone member states, as part of an overall EU/IMF rescue fund of 750 billion euros ($1 trillion).
Belgian Finance Minister Didier Reynders, who had proposed doubling the rescue fund, said he expected more discussion in the coming weeks about the size of the mechanism.
But economist Chris Scicluna of Daiwa Capital Markets said: "Anyone in the market who is expecting someone, somewhere to fund more support for the periphery, whether it be the EFSF or the ECB -- they're going to be disappointed."
All 27 European Union finance ministers formally endorsed an 85 billion euro EU/IMF assistance package for Ireland, clearing the way for the first loans to flow to Dublin once a tough austerity budget passes parliament.
The budget, including pay and unemployment benefit cuts and tax rises, is expected to be approved later on Tuesday after a key independent lawmaker promised to vote for it, ensuring battered Prime Minister Brian Cowen a slim majority.
At Monday's meeting, the IMF chief also suggested the ECB step up purchases of government bonds, effectively becoming a buyer of last resort for euro zone sovereign debt.
But ECB executive board member Juergen Stark, a renowned hawk, dismissed calls for the bank to accelerate its bond buying program. He also rejected the idea of a common European sovereign bond, which would bring down the borrowing costs of weaker nations, but could raise those of Germany.
There had been some expectation among investors that the euro zone might decide to take more radical steps, particularly after the IMF's intervention and a prominent call by two veteran ministers for joint "E-bonds."
EU officials noted that the bloc's leaders meet for a summit on December 16-17, due to approve proposals for a permanent crisis resolution mechanism.
Italian Economy Minister Giulio Tremonti, who co-authored the euro zone bond proposal with Juncker, insisted on Tuesday it would not require any change in EU treaties. However, German Chancellor Angela Merkel dismissed the idea on Monday and said it would require a major change in EU treaty rules.
One of her predecessors, former Chancellor Helmut Schmidt, who co-founded the European Monetary System in 1979, bitterly criticized Germany's response to the crisis in an interview published by business daily Handelsblatt on Tuesday.
He called the German Bundesbank, which has opposed ECB bond purchases, "reactionary" and opposed to European integration, and said Merkel "is not acting very cleverly."
(Additional reporting by Harry Papachristou in Athens and William James in London; Writing by Mike Peacock and Paul Taylor; editing by Mark Trevelyan)