March 9 (Bloomberg) -- There are those moments in the lives of political leaders and the destiny of nations when a bold move defines their place in history.

For German Chancellor Angela Merkel and her country, last week was one of those times. Both failed.

The setting was Brussels. The date was March 1. The event was a summit of European Union leaders. The subject was a plea by Hungarian Prime Minister Ferenc Gyurcsany for 180 billion euros ($225 billion) in loans for the beleaguered ex-communist countries of eastern Europe.

Led by Merkel, the response was a resounding “nein.”

It’s time Germany stepped up to the plate and played a leadership role commensurate with its status as the region’s largest economy, the biggest contributor to the EU budget and long-time promoter of European unity.

Germany has been a staunch supporter of the EU’s eastward expansion and the euro, which is used by 16 member states. Most of Germany’s exports go to EU markets. At the same time, Germany has insisted on tight budget-deficit criteria for EU members and a rule that bars one euro country from bailing out another.

That leaves Merkel squeezed between German taxpayers, who see little reason to foot the bill for foreign bailouts, and a fraying EU that threatens to unravel.

No Leadership

Avoiding that fate requires leadership, which Merkel and her big EU partner states have failed to exhibit. Eastern Europe is the bloc’s first line of defense, followed by the euro area. Several euro-area economies, including Ireland, Italy, Greece, Portugal and Spain are already in trouble.

Merkel is also stymied by another dilemma. Her Christian Democratic Union party has been losing voter support to the pro- business Free Democrats, and national elections are scheduled for September. An eastern European rescue package could further hurt the CDU at the polls.

Nonetheless, the chancellor must rise above such prejudices and show the world that the EU is something more than just a 27- nation trade association.

Not all eastern Europeans are in need of a bailout. Slovenia and Slovakia already use the euro and have been mostly shielded from the chaos afflicting the region. Those in the worst shape include Bulgaria, Estonia, Hungary, Latvia, Lithuania, Romania and Ukraine, which isn’t an EU member.

Poland and the Czech Republic have stronger economies, but they are vulnerable to an escalation of crisis in the region.

Coordinated Rescue

Germany probably can’t foot the entire bill for bailing out the East, but it should be able to persuade other EU countries to participate in a rescue operation, if only because it would serve their interest to save their banks from suffering huge potential losses. Austrian, Swedish and Italian banks have been especially big lenders and investors in the East.

Also if Germany was to agree to a bailout, it should insist that the banks with the most at stake in eastern Europe keep lending to the region and not use rescue funds to cut and run.

They can do all this without relaxing the criteria for east European countries seeking to adopt the common currency as some folks have suggested. Diluting the requirements for euro membership would only make life more difficult for the nations that already use it, possibly even triggering a speculative attack on the currency.

A healthier eastern Europe would reduce the risk of social unrest, deter the emergence of populist/nationalist leaders in the region, discourage protectionism and quell concerns about a breakup of Europe’s single market.

Gyurcsany on March 3 said he will continue to push for an EU agreement on a financing package for eastern Europe that would include private-debt restructuring, short-term financing for governments, bank recapitalizations and steps to limit the risk of foreign-currency loans.

This time around, Merkel shouldn’t be so quick to reject the package. It’s a second chance for the chancellor to build a legacy and show the world that the EU has the leadership it needs. Without it, the grand experiment is doomed.

(Michael R. Sesit is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Michael R. Sesit in Paris at at msesit@bloomberg.net

Last Updated: March 8, 2009 20:00 EDT