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* Vatican denies cardinal involved
* Crisis worst in Benedict's papacy
* Vatican tries to play down extent of scandal (adds comments by Vatican magazine editor)
By Philip Pullella
VATICAN CITY, May 28, The Vatican, engulfed in the worst crisis in Pope Benedict's papacy, on Monday denied Italian media reports that cardinals were suspects in an investigation into leaks of sensitive documents that led to the arrest of the pope's butler.
But while denying the reports, which said the butler was merely a courier in a behind-the-scenes struggle for power in the Holy See, the Vatican acknowledged that the often sordid affair would test the faith of Catholics in their Church.
The scandal exploded last week when - within a few days - the head of the Vatican's own bank was abruptly dismissed, the butler was arrested over leaks and a book was published alleging conspiracies among cardinals, the "princes of the Church".
Documents leaked to journalists allege corruption in the Church's vast financial dealings with Italian business.
Vatican spokesman Father Federico Lombardi told a news conference: "This is naturally something that can hurt the Church, and put trust in it and the Holy See to the test."
Italian newspapers, quoting other whistle blowers in the Vatican, said the arrested butler was merely a scapegoat doing the bidding of more powerful figures, punished because the Church did not dare implicate cardinals behind the leaks.
"There are leakers among the cardinals but the Secretariat of State could not say that, so they arrested the servant, Paolo, who was only delivering letters on behalf of others," La Repubblica quoted one leaker as saying.
The Secretariat of State is run by Cardinal Tarcisio Bertone, the pope's powerful right-hand man, and the scandal appears to involve a struggle between his allies and enemies, reminiscent of Renaissance conspiracies inside the Vatican.
It has been brewing for months, but since it burst into the open it has shaken the very heart of the Roman Catholic Church.
La Stampa daily quoted one of the alleged leakers as saying their goal was to help the pope root out corruption.
After an investigation inside the Holy See, the butler, Paolo Gabriele, 46, was charged on Saturday with stealing confidential papal documents. Leakers quoted by La Stampa, La Repubblica and other media said the leaking plot went much wider and higher.
Lombardi denied that any cardinal was being investigated for leaks. "I categorically deny that any cardinal, Italian or otherwise, is a suspect," Lombardi said.
The pope was being kept fully informed of the case, Lombardi said: "He continues on his path of serenity, his position of faith and morals that is above the fray."
BUTLER TO COOPERATE
One of Gabriele's two lawyers, Carlo Fusco, said his client, who is being held inside a Vatican police station, would cooperate fully with investigators who are trying to track down other suspects.
He said Gabriele, who attended mass on Monday morning and was visited by his wife, was "very serene and tranquil."
Critics of the pope say a lack of strong leadership has opened the door to infighting among his powerful aides - and potentially to the corruption alleged in the leaked documents.
Many Vatican insiders believe the butler, who had access to the pope's private apartment, could not have acted alone. He is being held in a "safe room" in the Vatican police station and has been charged with aggravated theft.
Now known in Vatican statements as "the defendant" - he was until Wednesday night the quiet man who served the pope's meals, helped him dress and held his umbrella on rainy days.
"I think this is a very serious moment it is a grave crisis because it has to do with the breach of trust in the inner circle of the Vatican," said Robert Moynihan," editor of the magazine Inside the Vatican.
"The pope cannot be sure that a document at his own desk isn't going to be taken and photocopied. It seems that the person taking those documents has been discovered but there is a general feeling that this represents more than that, that there is someone else behind it," Moynihan told Reuters television.
But Gianluigi Nuzzi, the Italian journalist who has received many of the documents over recent months and last week published his book "His Holiness", criticised the focus on rounding up leakers, rather than rooting out the corruption they expose.
"Surely, arresting someone and rounding up people and treating them like delinquents to stop them from passing on true information to newspapers would cause an uproar in other countries," he said. "There would be a petition to free them."
WEED OUT CORRUPTION
While news of the butler's arrest has filled newspapers in Italy and beyond, the Vatican's own newspaper, L'Osservatore Romano, has ignored the story. Some say this may be because the paper itself has been an instrument in the power struggle between Bertone's allies and foes.
The Vatican's announcement of the arrest of the butler came a day after the president of the Vatican bank, Italian Ettore Gotti Tedeschi, was fired after a no confidence vote by its board of external financial experts, who come from Germany, Spain, the United States and Italy.
Gotti Tedeschi's ousting was a blow to Bertone, who as secretary of state was instrumental in bringing him in from Spain's Banco Santander to run the Vatican bank in 2009.
The Vatican bank, officially known as the Institute for the Works of Religion (IOR), was set up during World War II to manage the accounts of Vatican agencies, church organisations, bishops and religious orders.
It has been involved in financial scandals - most notably in 1982 when its then-president, Archbishop Paul Marcinkus, was indicted over the collapse of what was then Italy's largest private bank, Banco Ambrosiano, with more than a billion dollars in debts. Banco Ambrosiano's chairman Roberto Calvi was found hanged under London's Blackfriar's Bridge in 1984.
In September 2010, Italian investigators froze millions of euros in funds in Italian banks after opening a probe into money laundering involving IOR accounts, which the bank denies.
The Vatican is trying to make the IOR more transparent and join an international "white list" of countries that comply with international safeguards against money laundering and fraud. A decision is expected within months.
Documents leaked over the last few months included letters by an archbishop who was transferred to Washington by Bertone after blowing the whistle on what he saw as a web of corruption in a memo that put a number of cardinals in a bad light. Other documents alleged internal conflicts over the Vatican bank.
"I feel very sad for the pope. This whole thing is such a disservice to the Church," said Carl Anderson, head of the Knights of Columbus charity group and a member of the board of the Vatican bank who voted to fire Gotti Tedeschi.
Anderson told Reuters Gotti Tedeschi was sacked because of "a fundamental failure to perform his basic responsibilities". Gotti Tedeschi has said he was ousted because he wanted the bank to be more transparent, but Anderson rejected that assertion.
"Categorically, this action by the board had nothing to do with his promotion of transparency," Anderson said. "In fact, he was becoming an obstacle to greater transparency by his inability to work with senior management." (Reporting By Philip Pullella; Editing by Barry Moody and Peter Graff)
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