July 22, 2011

THE NEW EUROPEAN plan for the debt crisis is far more comprehensive than the previous remedies continental leaders have prescribed. By slashing interest rates and stretching out maturities on much of Greece’s debt, it cuts that beleaguered country’s overall financial burden. By urging but not forcing private banks to take a “haircut” on their Greek bond holdings, it permits a previously unthinkable default without triggering payments on billions in credit-default swaps. And by enabling the $633 billion European bailout fund to recapitalize banks, lend short-term money and buy back distressed government bonds, it offers protection against “contagion” to Spain and Italy.

The plan also includes assurances that Greece is a unique case and that there will be no further haircuts for private bondholders; the European leaders backed up that pledge by offering Ireland and Portugal softer terms on their bailout loans.

Broad as it is, does the plan go far enough? Greece would still be left with a debt at least equal to its gross domestic product — or even 25 percent greater than GDP, according to Jacob Funk Kierkegaard of the Peterson Institute of International Economics. Many analysts think that any debt-to-GDP ratio greater than 100 percent is unsustainable given Greece’s chronically low growth rates, not to mention the fact that all Eurozone countries are supposed to keep their debts at 60 percent of GDP or less.

The initial market reaction was favorable: Spanish and Italian bonds both reversed their worrying plunge of recent days. But expect markets to begin challenging the new deal soon. It is a compromise between wealthy Germany, which had previously refused to put its taxpayers on the hook for more bailouts unless banks also took a hit, and the European Central Bank, supported by France, which had opposed any Greek default, lest all European sovereign debt be attacked by the markets.

Recent history suggests that the bond markets can be appeased, at least temporarily, by gradually widening Franco-German bailouts. Perhaps this iteration will buy the continent’s banks and other financial institutions time to clean up their balance sheets so that they’ll be better able to ride out the next market crisis, when and if it comes.

Europe is still groping for a permanent political fix, however. This agreement might, as its authors intend, represent the first phase of a gradual move toward effective economic governance by a more centralized European authority — the very thing economists have long identified as the crucial missing ingredient in Europe’s single-currency project.

But “economic governance” is one of those phrases that obscures as much as it explains. To put it another way, the euro’s long-term survival depends on these conditions: For the indefinite future, Northern Europeans must be willing to bankroll Southern Europeans, and Southern Europeans must be willing to live under harsh austerity programs dictated by Northern Europeans. And voters in both regions must accept having even less say in the matter than they do already. The people of Europe may indeed make that choice. But we’re not sure that they have done so yet — or that their leaders have even honestly presented it to them.