Europe Buys Some Time

The stock market liked the European deal that was announced in the wee hours of Thursday morning. At this writing, the Dow is up 268 points. But the market, as is so often the case, could well be wrong.

For starters, this is not yet a done deal. The European leaders agreed that the banks will take "voluntary" losses of about 50 percent on their holding of Greek bonds, so that the Greek economy can gain some room to breathe—but the banks did not agree.

Charles Dallara, who heads the international bankers' lobby, the misnamed Institute for International Finance, was quoted by The Wall Street Journal as saying that "there is no agreement on any element of a deal." He later told CNBC that the deal was "voluntary," permitting issuers of credit-default swaps (mostly banks) to avoid payments they would have to make in the case of a formal restructuring or a default. But never underestimate the ability of banks to impose their losses on somebody else.

Under the proposed deal, the banks also must come up with about $150 billion of new capital, at a time when their share values have been falling. It is by no means clear where they will get that money.

The agreement, to help countries that are in over their heads because of so much borrowing, is itself heavily reliant on ... still more borrowing. The proposed European Financial Stability Facility, the EU's bailout fund, is to be increased to more than double its present size, to $1.4 trillion. But that, too, will require more borrowing.

European leaders, led by French President Sarkozy are going hat in hand to the Chinese to get Beijing to invest more money in bonds that will get some kind of official guarantee, to produce the $1.4 trillion. The Chinese have made clear that in return they want the Europeans to stop filing trade cases complaining against Chinese mercantilism. So whatever money Beijing does put up will not be free.

Two encouraging things are worth noting, however. German Chancellor Angela Merkel was able to persuade the German Bundestag to put aside Germany's parochial national interests and to support the larger rescue package by an overwhelming margin. Germany is sitting pretty, but has more to lose than any other nation of the Euro collapses. This finally dawned on official German opinion.

And the European Central Bank is now led by the respected and pragmatic Mario Draghi, former head of the Bank of Italy. Draghi, who officially succeeds the far more orthodox Jean-Claude Trichet next week, has already made clear that the ECB will step up its purchases of sovereign debt, to keep speculative market pressures from destroying the ability of Italy, Spain, and other weaker EU nations to access credit markets.

For now, the progress has reassured capital markets. But the whole deal is jerry-built, and far from complete. Even if the details are worked out as proposed, the entire approach is dependent on taking a system that is suffering from too much leverage—borrowing—and adding still more leverage. Nor are these emergency rescues coupled with any fundamental reforms of a speculative private financial system that caused the damage in the first place.

Faced with a complete financial collapse, Europe has managed to buy a little more time. It remains to see whether European leaders will use this additional time for the more drastic reform that is needed to escape a cycle of lurching from crisis to crisis and inflicting austerity as the perverse cure.

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