European finance chiefs cast about for a strategy to halt Greece’s debt spiral, reviving previously discarded ideas and sharpening a dispute with central bankers as the rot spread to Italy.

As exploding bond yields in Italy and Spain brought the crisis closer to the heart of the euro area, Europe’s search for answers took it back to a proposal scuttled by Germany this year to buy back discounted debt. Also being considered are remedies that would put Greece into temporary default, countering pleas from the European Central Bank to avoid that step at all costs.

The brainstorming in Brussels failed to stem the plunge in European shares and bonds of the most-debt laden countries, reflecting investor concern that their efforts will be overwhelmed. The euro fell to its weakest in four months. Italy’s 10-year bond yields exceeded 6 percent, reaching the highest since 1997. Milan’s stock index fell to its lowest in more than two years.

“They are misjudging the size of the problem they face,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Plc. “This is a euro-wide crisis and again they are behind the curve.”

Nine hours of talks yesterday yielded a six-paragraph statement in which the 17 euro governments pledged to flesh out a new master plan “shortly” to end the 21-month-old crisis, without setting a timeline. The meetings resumed today with all 27 EU finance ministers plotting a response to the release of bank stress tests later this week.

Default Risk

The decision to have another look at reinforcing the European Financial Stability Facility, the 440 billion-euro ($618 billion) bailout fund that was beefed up only last month, came after talks with bondholders over a “voluntary” rollover of Greek debt ran into a threat by credit-rating companies to put Greece in default.

Prodded by the ECB, the euro’s guardians said a bailout fund set up last year may be used to buy bonds in the secondary market or enable Greece to retire its debt at a discount. They offered another cut in rates on its emergency loans.

“There are a variety of ways of enhancing the flexibility,” European Union Economic and Monetary Affairs Commissioner Olli Rehn told reporters late yesterday. Buybacks are “one of those. I would at this stage not exclude any option. But instead we are exploring these possibilities.”

Dutch Demand

Finance ministers offered varying interpretations of the commitment to explore a wider range of options. Dutch Finance Minister Jan Kees de Jager insists on getting bondholders to roll over Greek debt even if that results in the “selective default” opposed by the ECB.

“We managed to break a very difficult knot of a contradictory statement, on the one hand that you are saying that you want a private sector involvement, and on the other hand that you want to avoid a selective default,” de Jager told reporters today. “Now we can do the work. In the next two weeks the euro working group can prepare a broader mandate.”

The statement singled out the ECB as opposing a “credit event or selective default.” Luxembourg Prime Minister Jean- Claude Juncker, the meeting’s chairman, said this doesn’t mean that European governments “would do everything in order to provoke a credit event.”

Greece, the trigger of the debt shock, was the only country mentioned. Juncker said the reassurances are “offering adequate responses” to concerns about Spain and Italy as well.

Papandreou’s Complaint

Europe’s lunge back to basics came after Greek Prime Minister George Papandreou complained that a “cacophony” had sowed “panic” that overwhelmed the budget cuts that he pushed through his parliament amid street riots last month.

The uphill struggle for solvency in Athens was dramatized by data yesterday showing the central government’s deficit widened 28 percent in the first half of 2011, with spending surpassing targets and revenue falling short.

Greece last week obtained European and International Monetary Fund assurances of a loan payout of 12 billion euros in July, part of the 110 billion-euro package it was awarded in May 2010.

A second package will also include lower interest rates and longer repayment times for official loans, the statement said. In a nod to demands by Finland and Slovakia, it said Greece might be required to put up collateral.

‘Too Dangerous’

In a letter to Juncker, Papandreou also said a French bond- rollover proposal under discussion with banks was potentially “too expensive, too little and too dangerous” and might tip Greece into formal default.

With Greek 10-year debt fetching less than 55 cents on the euro, buybacks were forced back onto the table by the Institute of International Finance, a group representing more than 400 banks and insurers that has tried to broker an accord on the French proposal.

Rejected by Germany earlier this year, the buybacks would pare Greece’s debt burden of 142.8 percent of gross domestic product by enabling it to retire bonds at a discount. German resistance centered on using taxpayer money to help spendthrift countries wriggle out of their debt.

German Finance Minister Wolfgang Schaeuble came to yesterday’s meeting opposed to a further reinforcement of the fund, saying there is “no discussion whatsoever” of another boost to its firepower. He wasn’t asked about buybacks. He is slated to speak to reporters after the meeting ends later today.

Italy, a focus of German concern in the 1990s runup to the euro with debt over 100 percent of GDP, returned to the forefront as investors dumped Italian bonds and stocks. Italy now has Europe’s second-highest debt load, at 119.0 percent of GDP in 2010.

Spread Widens

Italy’s 10-year bond spread over Germany surged to 326 basis points today, a euro-era high. The extra yield, a sign of investors’ skepticism about Italy’s fiscal health, has more than doubled from a 2011 low of 122 basis points on April 12.

Italian assets were upended by doubts whether Prime Minister Silvio Berlusconi, plumbing record-low approval ratings with two years left in office, will muster the strength to push through 40 billion euros in planned deficit-cuts.

The bond rout continued to engulf Spain, the fourth-largest euro user. Spanish 10-year yields climbed 23 basis points to 6.26 percent, stretching the spread over German debt as wide as 364 basis points, also a euro-era record.