June 12, 2012

THAT WAS QUICK. Over the weekend, European leaders announced a $125 billion package to recapitalize Spain’s banking system. On Monday morning, financial markets reacted positively, seemingly accepting official assurances that, this time, Europe had finally put a big enough plan in place to handle the financial challenge du jour — and had done so in a timely manner. As the day wore on, however, and investors started asking about the details, their enthusiasm waned. By Tuesday, markets had rendered a thoroughly negative verdict, with interest rates on Spain’s 10-year bonds spiking above 6.8 percent, and Italy’s surging as well.

What went wrong? Though certainly large enough to plug the expected hole in Spanish balance sheets, the bailout, underwritten by Germany and other financially solvent countries, was delivered in the form of a loan for which the Spanish government is ultimately responsible. Markets worry, reasonably, that Madrid is no more capable of paying off this obligation than its existing mountain of debt, given the deep recession plaguing its economy.

Things might have been different if the money had gone straight into the banks themselves, but Berlin vetoed anything that looked too much like a direct bailout of another country’s profligate bankers. Markets were also unhappy to learn that the creditors of the bank bailout might outrank all others in the hierarchy of Spanish obligations, which would be another reason, on top of many others, for private investors to shun Spanish bonds.

True, these are essentially matters of tactics. But the questions demonstrate the continuing strategic weakness of Europe’s approach to the debt crisis that has been destabilizing the continent and the entire world for more than 21 / 2 years. Quite simply, Europe needs an approach to its problems as massive and as confidence-inspiring as the Troubled Assets Relief Program and related measures were for the United States in the fall of 2008. And it still either can’t, or won’t, devise one.

The Spanish bailout could plug the hole in that country’s banks, for a time, but it’s not a permanent remedy for capital flight unless and until depositors get the idea that their savings are guaranteed by some solvent entity, comparable to the U.S. Federal Deposit Insurance Corp. Nothing like that exists in Europe, and German taxpayers are not eager to underwrite one. The Germans are still hesitant to co-sign eurobonds for their debtor neighbors, and they’re really reluctant to accept greater inflation within the German economy, to accommodate some relaxation of the deflationary austerity that Germany is essentially imposing in return for bailouts.

Yet all of these elements, or some version of them, may be necessary to stave off the collapse of the euro and, with it, the European economy. There is encouraging talk of a new Europe-wide banking supervision agency, but it won’t be ready until next year at the earliest, and there are thorny questions about the role of London’s financial center, which is part of the European Union but outside the euro.

Europe can probably limp along at least until Sunday’s election in Greece, which may supply that country’s long-awaited verdict on whether it wants to stay within the euro — or to take its chances on national default and a new national currency. Perhaps it was too much to hope that Europe’s paymasters in Berlin would play any more cards than they absolutely must before they hear from Athens. But there isn’t much time left.