The European Union is considering creating a rescue fund that could herald fundamental changes in the 27-country bloc and bring closer economic cooperation following Greece's debt crisis.

The idea of a European monetary fund was floated over the weekend by German Finance Minister Wolfgang Schaeuble, who said he favored an institution that commanded the experience of the International Monetary Fund and similar executive powers.

The European Commission, the EU executive, said on Monday it was ready to propose a rescue instrument for the 16 countries using the euro but did not say whether it would involve treaty changes, which would require the backing of all 27 EU states.

It is unlikely such a fund would be in place in time to help Greece through its debt crisis, which threatens the credibility and unity of the euro zone, but it could help tackle similar crises if they arise in other heavily-indebted EU states.

The Commission is ready to propose such a European instrument that has the support of euro zone member countries, Economic and Monetary Affairs Commissioner Olli Rehn said in a newspaper interview published on Monday.

His spokesman, Amadeu Altafaj, said it was too early to say whether the fund would be just a financial instrument or a new institutional body with its own staff and budget. He said the proposals could be in place by the end of June.

In Germany, Clemens Fuest, who chairs the Finance Ministry's technical advisory committee, said an European Monetary Fund would make sense only if it permitted states to go bust.

Such a fund must provide for an insolvency procedure for countries, he told Reuters. A solution must be found for this, so that one country's bankruptcy doesn't lead to a new financial crisis, a Lehman II.

The failure of the U.S. investment bank Lehman Brothers in 2008 helped precipitate the global financial crisis.

Fuest said an EMF could use its reserves to buy up the debt of bankrupt countries, but bondholders should not be bailed out entirely and would have to accept haircuts.

MORE INTEGRATION?

The Commission will discuss the ideas being floated at its regular meeting on Tuesday, but is unlikely to reach any decision, the spokesman said.

He said it was premature to say whether the creation of the new fund would involve changing the EU's treaty, which would likely be a long and tortuous process.

The EU's Lisbon treaty that came into force on December 1 does not allow for bailing out euro zone countries, but it allows for aid to EU members outside the currency area.

Some economic analysts said the fund could be based on the treaty's provision that allows a group of countries to cooperate on certain matters more closely than others. Following that path would boost policy coordination in the euro zone, but also leave behind EU countries outside the currency bloc.

To be genuinely effective, the fund's creation should be accompanied by increased political and fiscal cooperation, something that many countries have opposed so far for fear of ceding too much power to EU institutions.

If the fund marks the start of recognition that there needs to be further political integration, then great. If it doesn't, all it will be is sticking plaster, said Simon Tilford, an analyst at the London-based Center for European Reform.

Euro zone finance ministers discussed issuing a common bond for the single currency area three years ago, but the idea was rejected by Germany.

But the German government may have changed its mind because it faces popular opposition to any use of German taxpayers' money to bail out Greece, European diplomats said.

Federalists in the EU like the idea of the fund, since it would probably mean closer integration of its members, one EU diplomat said.

The idea of creating a European Monetary Fund was first proposed by economists Daniel Gros of the Center for European Policy Studies and Thomas Mayer of Deutsche Bank. They said it should be funded initially by market borrowing and eventually by contributions from states with debts and deficits exceeding EU limits.

European Socialists proposed last week setting up a rescue fund as part of the European Investment Bank (EIB), the EU's government-owned financing arm which issues bonds to secure cash for projects such as energy or motorway construction.

(Additional reporting by Noah Barkin in Berlin and Paul Taylor in Paris, Lisa Jucca in Milan, Paul Carrel, Rene Wagner, Madeline Chambers and Gernot Heller, in Berlin; editing by Stephen Nisbet)

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