They had to stay up until the bright crack of dawn, but European leaders emerged Friday from their summit in Brussels with a deal to ease the economic crises in Spain and Italy. Financial markets around the world are going crazy, thrilled that the latest euro plan was far bolder than anyone expected. Other analysts are more skeptical. So should we be optimistic or pessimistic about the fate of Europe?
First, let's look at what E.U. leaders actually did. The biggest part of the deal (pdf) was to move the euro zone even closer to a "banking union." Recall that one of the euro zone's big structural woes is that each individual country has pledged to back its own banks if they run into trouble. Trouble is, as this chart from Barclay's Capital shows, the banking sectors in many euro zone countries are far too big and unwieldy for those nations to rescue by themselves:
To put this in perspective, the liabilities of the entire banking sector in the United States are "only" about 100 percent of U.S. GDP. That's one reason, Barclay's notes, why few people question the ability of the U.S. government to act as a "rescuer of last resort" if its banks fail. By contrast, the liabilities of the Spanish banking sector are about 300 percent of GDP. And the Spanish government doesn't have endless resources the way the U.S. Federal Reserve does. Here's how Barclay's sums it up: "[T]hat goes to the heart of the problem with Europe's banks; simply put, they are much too big for their individual sovereigns to protect credibly."
That's a major reason why Spain's now in crisis. Some of Spain's banks, having made bad bets during the housing bubble of the 2000s, are in trouble and need a bailout. In mid-June, the Spanish government made a deal to borrow $125 billion from the rest of Europe in order to rescue those banks. But then everyone started panicking that the Spanish government itself might have unsustainable debts.
So that brings us to the deal that came out of the euro summit. Rather than have individual euro nations continue to try to prop up their own banks, which are too big for them to handle, the entire euro zone will band its resources together and use its new, $634 billion bailout fund — the European Stability Mechanism — to rescue troubled banking sectors directly, starting with Spain and possibly Ireland. In exchange, the European Central Bank will start regulating and supervising different banks around the continent. (There's another key component of a banking union, deposit insurance, which may prove a harder sell to Germany.)
What's more, the euro zone will authorize its bailout fund to lend money to Italy, should that country run into trouble borrowing money on the open market. Italian Prime Minister Mario Monti saw this as a major priority, in order to buy some time and space to pursue pro-growth reforms within Europe. “Italy does not plan to activate the mechanism for now," Monti said, "but I do not exclude anything for the future.”
Will these new measures end the crisis? That's not so clear. Ever since the plan was announced, stock markets around the world have been surging. There's lots of optimism. But we've seen these short bursts of optimism before — they tend to fade quickly once euro zone politics kick in and make these rescue plans prove to be harder to enact than thought.
So now the pessimism: Over at The Atlantic, Matthew O'Brien asks some tough questions about the latest plan, which still needs to be approved by individual countries (Finland might not be so thrilled at handing money over to its southern neighbors). Lisa Pollock also worries about the fine print.
One major problem? The European bailout funds don't have unlimited resources. If they throw $125 billion at Spain's banks and another couple hundred billion toward Italy, pretty soon they'll be running low. The only entity with unlimited euros is the European Central Bank. And right now, there's no talk of using the ECB to provide bailouts. Which means that this latest move might have just forestalled the crisis, rather than ending it permanently.