EU Debt Deal: Déjà Vu All Over Again?

Let’s be fair: the 4 AM announcement Thursday by European Union leaders of a new and urgently needed package of measures to confront the euro zone debt crisis is a significant break-through that may eventually represent the corner being turned in the seemingly endless drama. And because the accord pledges massive sums of money to address the most crucial concerns in the complex emergency, response to it was accordingly positive. Following advances in Asian markets on the news, European bourses opened  with advances Thursday, with traders clearly feeling steps taken in Brussels were in the right direction towards overcoming Europe’s turmoil.

Let’s hope that upbeat attitude persists, but let’s not be stunned if it doesn’t. Because let’s be honest about another reality of Thursday’s development: it was only the most recent play by governments in a global confidence game that’s certain to shift and surge again before it’s all over.

That’s not “confidence game” in the usual, illicit “con” sense. Instead it more literally describes attempts by EU leaders to inspire confidence and calm in financial markets so they’ll cease the doubt-inspired dumping of bonds, and bets against iffy sovereign debt that severely complicates efforts by euro zone officials to overcome current crisis. To that end, the relatively timid action  taken earlier by European leaders was subsumed by the far more dramatic measures adopted Thursday–an emphatic upward ratcheting designed to prove their determination to tackle the evolving catastrophe once and for all.

In doing so, the agreement obliges private banks to increase the amount of written-off Greek debt they own from 21% to 50%, and raise around $147 billion in new reserves as protection from possible sovereign debt default in the euro zone. It also calls for funds available to the European Financial Stability Facility (EFSF) to increase significantly from the current $616 billion reserve. It’s largely anticipated the final sum will amount to around $1.4 trillion. That’s a mighty chunk of change, to be sure; but like the $147 billion in required new bank reserves, it’s only about half of what many observers called the Big Bertha amounts required to convince even worst skeptics in financial market actors of leaders’ resolve to overcome the debt crisis and save the euro from implosion.

Still, reaction by stock markets Thursday makes it clear investors approve of the steps that were taken, and have regained some of the confidence lost to repeated political dithering and delay. The Brussels summit was, after all, the tenth of its kind in just eight months. The last one resulted in a July 21 accord establishing the EFSF, which is intended to provide an emergency funds if necessary to Greece and the euro zone’s other most debt-mired countries. But doubts within markets that the steps taken in July were enough have surged since, creating urgent expectation for something more decisive to be done to quell the storm. It was for that reason Thursday’s break-through by EU officials–who’d previously been deeply divided on just what measures to adopt during the summit—was seen as a welcome, if belated show of political determination to deal with the crisis. As such, it won an immediate victory: scoring big in its confidence game with re-invigorated international markets Thursday.

So why the dissonant soundtrack signaling the arrival of a “maybe, but…” whining in the background? Because as events since July—and, indeed, during every serious crisis in the recent past—have shown, markets are really lousy measures of policy merit and economic direction. In fact, they’re poster children for bipolar disorder gone amok under the influence of dog-eat-dog self-interest. They generally respond to any good news with the same amount of inordinate glee  expressed as dread and doom when things look less rosy (making their relationship with policy makers—as my colleague Michael Shuman points out–similar to the one between a groundhog and the sky). Their good at advancing their interests, not so hot on bigger pictures, and often the seers of self-fulfilling prophesies.

Therefore, don’t be surprised to see investors start growing grouchy again once their post-summit buzz starts to wear off under the return of business-as-usual grind. Despite the deference they enjoy as the amorphous, invisible hand of wisdom and logic Adam Smith is (incorrectly) said to have bestowed upon them, markets more frequently act like self-absorbed, small-minded frat boys who get wrapped up in the rush and excitement at the start of a drunken party: after the shouts, high-fives, and cheers about how rad everyone is, they tend to spend the next day grousing about how deeply life suck–right until someone else breathes new word of another party. The idea of holding themselves accountable for their role in the sickly, dysfunctional, reoccurring situation never even occurs to them. That is seen boldly in another factor driving the crisis: that it’s been market attacks on bad-smelling debt that has increased the urgency of the situation via higher borrowing rates (and forced leaders to scramble for ways to offset that) in the first place. Did someone mention self-fulfilling prophesies?

The other reason we’re virtually certain to see markets and pundits alike get over their current post-summit cheer is because if the outlines of the deal seem (and is) impressive, there’s still little detail on where the money behind it will come from. Some ideas about how the $1.4 trillion in bailout funds could be generated were mentioned, but those raise as many questions as they do answers. Among those–as Michael notes–is the suggestion of asking China and other cash-rich emerging economies to invest money in the bailout scheme. Why not—the U.S. certainly hasn’t been too shy about financing today on IOUs due to China tomorrow. But there will doubtless be a heavy price to pay for those loans eventually, since Beijing can hardly be expected to save Europe’s backside for Brownie Points alone.

The same suspicion surrounds the agreement with European banks to increase their write-offs of Greek debt to 50%. Bankers had fought off the initial government figure of 60% with warnings that any burden imposed on banks that they didn’t themselves agree to would bring dire consequences for financial markets in the economy in general. Those were basically threats to leaders not to make banks finance crisis resolution any more than they were willing to, or else. Early reports Thursday say banking representatives left Brussels claiming they’d surrendered less than what they’d set as their maximum limit. Meaning, Athens’ very creditors appear to have felt  a higher degree of debt forgiveness will be needed to prevent Greek from ultimately defaulting—and had figured they’d have to eat more of that than they were finally asked to. If so, that means either the public will have to make up that missing piece—or it will have to be extracted at some future summit. Did someone say “reoccurring”?

That’s all speculation about what the coming days and weeks may bring. Let’s hope it winds up being misguided skepticism that willfully discounted what ultimately turns out to Thursday’s spot as the beginning of the end to Europe’s debt crisis. Just in case, though, watch this spot.