Is Europe Fixed Already?

Markets all over the world are cheering the headlines coming out of Europe. Is this what we had been waiting for or we are seeing another episode of ‘irrational exuberance’ that will soon subside? Is Europe fixed already?

My take is that the market’s optimism today is not misplaced as the European leaders have announced their intention to pursue substantive changes. This is by no means everything that everyone has been asking them to announce. But it is nevertheless a good-enough start that puts the region on track for shared liabilities and a banking union down the road.

Markets are forward-looking pricing mechanisms; they look ahead in putting a price tag on assets. So we don’t need each and every broken piece of the Euro-zone framework fixed before asset prices will reflect the ‘fix’. A credible enough roadmap would suffice – and that’s what we are seeing in the market today.

Details are still sketchy, but European leaders seem to havefinally realized the need tobreak the ‘feedback loop’ between undercapitalized banks and their distressed sovereign regulators by letting the permanent bailout fund directly inject capital into the banks. They will do that after they set up a common Euro-zone wide bank supervising institution. They also agreed to let the bailout fund directly purchase government bonds of member countries without requiring them to go through onerous austerity programs like what Greece, Ireland, and Portugal endured.

With respect to the immediate needs of Spain, they agreed to not give priority to their loans over existing government debt and even let the currently agreed bank bailout loan eventually transferred to the common bailout fund. There is also a growth centric program through increased spending that had been agreed to in pre-summit meetings. All in all, they have set the process in motion to create a banking union, kind-of mutualize debt and agree on a sequencing of these measures.

This doesn’t mean there wouldn’t be disappointments down the road; you can almost guarantee there would be. National politicians, who have thus far been behind the curve on everything, will need to sell to their citizens why they need to sign off on ceding their fiscal sovereignty to Germany. Many European nations don’t exactly have fond memories of the last time Germany was their overlord. Bottom line, Europe is not fixed yet, it’s a very long journey. But they made a good start today.

Do you agree?

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