A Euro deal from Brussels
In their agreement last night, European leaders in Brussels managed to exceed expectations, which had been set extremely low. But their terse statement leaves a lot of unanswered questions - especially when it comes to how and whether the eurozone's rescue funds will be used to bring down the cost of borrowing for countries like Spain and Italy.
Stocks are up, and Italian and Spanish ten year bond yields are down by around a third of a percentage point. By all accounts, investors are pleasantly surprised, but not all of them euphoric in their response to a statement which is little more than three paragraphs long.
None of those paragraphs, it is worth remembering, mention the issue that causes the most neuralgia for Germany: collective guarantees on eurozone sovereign debt.
In fact, short-term moves toward that - the creation of Euro-bills, for example - were barely discussed at last night's meeting, because Chancellor Merkel had made her position abundantly clear (see my blogs earlier this week on this).
So, what did they achieve?
First, and in the long term possibly most important, they have committed themselves to the idea of a single supervisor of eurozone banks - the European Central Bank - which could have the capacity to inject capital into troubled banks directly, without the debt going on to the books of the sovereign government.
This is not exactly a shock - we knew it was the area where progress was most plausible. But it is a long way from where they were a few months ago and it could mark an important step, not only toward a single European banking union but toward the provision of more credible support for troubled banks in Spain and other countries. Of course, it also raises big questions for previous deals which did load debt on to the sovereign - notably Ireland.
In theory, that agreement could improve market confidence in countries where there has been a vicious "feedback loop" between a troubled banking system and the sovereign (notably Spain and Ireland).
But, the insistence that the new supervisory capacity be in place before any money changes hands surely raises questions about how and when any of this will happen.
Official sources say the details will be ironed out before the end of the year. Perhaps. But even so, it's not clear where that leaves the financial package for Spain to recapitalise its banks, which is already structured to go via the government.
In the statement, the leaders "urge the rapid conclusion" of the negotiations over that deal and indicate that the money, in the first instance, will still come from the EFSF. That suggests the bail-out will indeed add to Spanish public debt, at least until the new system for injecting capital into banks has been agreed.
In that sense, the biggest beneficiary of this agreement may well turn out to be Ireland, not Spain - because the new system has a better chance of being in place when its bailout package needs to be renegotiated, next year.
Second, and related, the leaders say that when the ESM takes over the Spanish bailout programme from the EFSF, that money will not get "seniority status" over private investors - it will have to stand in the same line to get its money as all the country's private creditors.
That is important, too. The fact that ESM lending would take seniority was another big downside to the recapitalisation programme in the eyes of investors. But again, the way the statement is written it seems only to apply to Spain.
There is no indication that the European Central Bank, for example, will be forced to take losses on the Greek, Spanish, or Portuguese government bonds it has purchased, in the event that those countries end up having their sovereign debt restructured or partly written off.
When Greek debt was restructured, elaborate measures were taken to avoid the ECB taking a formal loss on its investments - even as private investors were seeing the value slashed. Investors will draw their own conclusions, but there is nothing in this statement to prevent that from happening again.
Finally, the leaders say they will use "the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets" for members of the eurozone who are abiding by all their various eurozone commitments. And they "welcome that the ECB has agreed to serve as an agent to the EFSF/ESM in conducting market operations in an effective and efficient manner".
This has some in the financial markets convinced that the ECB is about to offer the ESM a banking license, so it could theoretically borrow an almost unlimited amount to buy Italian or Spanish sovereign debt in the markets, and so put a cap on their cost of borrowing.
If that is what this statement means, it would indeed be a game changer - and mark a major climb-down for Chancellor Merkel. But that is not, actually, what it says. And the mention of the ECB acting as an agent, in this context, seems disingenuous, at best.
The ECB has already agreed to act as these institutions' "agent" when and if they go out to buy government bonds. That does not mean underwriting their purchases. Nor does it mean giving them a banking licence. It just means buying the bonds for them, just as stockbrokers buy shares on behalf of their clients. If the leaders meant to suggest more than this, you wonder why they did not spell it out.
As I noted in my last post, the bailout funds won the authority to buy government bonds nearly a year ago, in the July 2011 Summit. Presumably the leaders wanted to use them "in an effective and efficient manner" then as well. But without some form of access to the ECB's balance sheet it is not clear they can.
The ESM is backed by government guarantees worth up to E500bn. Compare that to the E2.7 trillion in outstanding Italian and Spanish sovereign debt and you see why the financial markets might well not take ESM purchases very seriously if they are not backed by the ECB.
Bottom line? The leaders have made progress - some of it important, even if the broad outlines were expected. To Chancellor Merkel's credit, they have not lurched for a short-term gimmicky version of euro bonds to appease the markets, which could make life even more difficult down the road. And they have changed the mood in the markets, at least for a while, even if there are many big questions raised by their statement which might not be answered any time soon.
This Summit may not, in the end, be a game-changer, but it could have been a lot worse.