By Barry Moody and Harry Papachristou
ROME/ATHENS (Reuters) - - Italian Prime Minister Silvio Berlusconi became the biggest political casualty of Europe's debt crisis on Tuesday when he announced he would step down after being stripped of his majority in parliament.
Berlusconi said he would leave office after parliament approves a budget law that includes reforms demanded by Europe, which is struggling to prevent the debt crisis from spreading to the third largest economy using the euro single currency.
Greece, ground zero of the crisis, is scrambling to win emergency funds to avert bankruptcy as soon as next month, and political parties argued over a new coalition government to replace that of Prime Minister George Papandreou, who has also announced this week that he will step down.
Berlusconi's imminent departure spells the end of the flamboyant billionaire media magnate's 17-year dominance of his country. His failure to implement reforms fueled a party revolt, and votes on the budget measures and his resignation could come as soon as this month.
Berlusconi told his own Canale 5 television station that the only option now was an early election, which could prolong the uncertainty that has sapped market confidence.
President Giorgio Napolitano he would hold consultations on the formation of a new government. Napolitano is thought to favor a technocrat or national unity government for Italy, similar to the solution being put in place for Greece.
That would please markets that have driven the cost of borrowing for Italy's government to 14-year highs. Traders pushed the yield on benchmark 10 year Italian bonds to 6.79 percent, a level unseen since 1997.
Such levels effectively make it unaffordable for Italy to continue to finance its own debt, and are similar to levels that forced Ireland, Greece and Portugal to take bailouts. Italy, however, is widely regarded as being too big to bail out.
Berlusconi's government won a key budget vote on Tuesday after the opposition abstained. But it secured only 308 votes in the 630-seat lower house, eight short of a majority.
Pier Luigi Bersani, leader of the main opposition Democratic Party, said Italy ran a real risk of losing access to financial markets.
"I ask you, Mr Prime Minister, with all my strength, to finally take account of the situation ... and resign," Bersani said immediately after the vote.
ON THE ROPES
The news that Berlusconi had finally agreed to resign came after European markets closed but had an immediate positive impact on markets in the United States. The euro jumped against the dollar and U.S. stocks edged up.
Earlier, Berlusconi's key coalition ally Umberto Bossi, head of the devolutionist Northern League, said Berlusconi should be replaced by Angelino Alfano, secretary of the premier's PDL party. "We asked the prime minister to stand down," Bossi told reporters outside parliament.
The center-left opposition said they abstained to lay bare the weakness of Berlusconi's support while allowing formal ratification of the 2010 budget.
Even when Berlusconi goes, there is no guarantee that reforms to cut the debt mountain and boost growth will be quickly implemented, and relief on markets may not last long. There is no agreement among political parties on either a national unity or technocratic government.
Brussels is putting inspectors in place to help supervise Italian reform. An EU economic surveillance mission will start work in Rome on Wednesday.
Finnish Prime Minister Jyrki Katainen said Italy was just too big to bail out. "It is difficult to see that we in Europe would have resources to take a country of the size of Italy into the bailout program," he told parliament in Helsinki.
LABOURING IN ATHENS
In Greece, the ruling Socialists and the conservative opposition were laboring to agree on a national unity government, expected to be headed by former European Central Bank vice-president Lucas Papademos.
The aim is to establish a "100-day" government to push a 130 billion euro ($180 billion) bailout package, including a "voluntary" 50 percent writedown for private sector bondholders, through parliament before elections in February.
Papandreou, the son and grandson of prime ministers, said farewell to his cabinet at the meeting, a participant said. He asked ministers to tender their resignations.
"Negotiations are being finalized with Papademos as PM," a Socialist party source told Reuters.
However, some politicians in the opposition New Democracy party were resisting an EU demand for a written commitment to the new bailout program with its harsher austerity measures.
Euro zone finance ministers, meeting in Brussels, agreed on Monday on a roadmap for boosting the currency bloc's 440-billion-euro ($600 billion) rescue fund to shield larger economies like Italy and Spain from a possible Greek default.
But with bond investors increasingly on strike, there are doubts about the efficacy of those complex leveraging plans.
In a sign that Italian banks are increasingly shut out of wholesale money markets, the ECB reported they needed 111.3 billion euros in central bank funding in October, up from 104.7 billion euros in September and a mere 41.3 billion in June.
Even the European Financial Stability Facility, the euro zone's bailout fund, had difficulty finding buyers for its top-notch AAA-rated paper on Monday, drawing barely enough bids for 3 billion euros of 10-year bonds issued to support Ireland.
EFSF head Klaus Regling cited a "very difficult" market climate and uncertainty about the fund's future profile as factors in the weak demand.
In Brussels, the 27 European Union finance ministers failed to agree on how to strengthen banks to cope with the sovereign debt shock without halting lending to businesses and consumers.
Options on the table included offering state guarantees to borrower banks or injecting cash into the European Investment Bank, the EU's project finance arm.
(Additional reporting by Emilia Sithole-Matarise in London, Paolo Biondi in Rome, Sarah Marsh in Berlin, Valentina Za in Milan, John O'Donnell and Jan Strupczewski in Brussels, Jussi Rosendahl in Helsinki; Writing by Paul Taylor and Peter Graff)