Half time break

Everyone Bails Out Everyone

WSJ Editorial

European deal has something for everyone, except the real problem.

Is anyone surprised at what Europe wrought? Contrary to headlines, European policy makers did not leave Brussels yesterday morning with the "final, even groundbreaking" plan to end the euro-zone's debt crises that they had promised earlier in the week. Details are still sketchy on many of the announced measures, including those to increase the firepower of the European Union bailout fund and prop up the continent's banks. Remaining disagreements are serious, and that means we're far from through with euro-crisis summitry.

What the summit does highlight, however, is that Europe's piecemeal approach is not going to cohere into a real or lasting solution if policy makers continue to ignore the underlying economic anemia that has afflicted the economies of Europe for decades. The patient has risen from his bed and not fallen down. This is one definition of progress.

Thursday's deal offers the sort of grab-bag familiar in Brussels. Greece gets another package of bailout loans, totaling €130 billion in value. Various parts of the EU's bailout machinery will be tweaked or boosted. But let's climb across the deal plank by thin plank.

The biggest accomplishment is the agreement to impose a voluntary 50% write-down on private holdings of Greek debt. This is progress for a Continent that dared not to breathe the word haircut only months ago.

But that's small consolation now that the European Central Bank, the International Monetary Fund and euro-zone governments hold about 40% of all Greek debt, a figure that will only grow as privately held bonds mature. As long as these institutions refuse to take haircuts on their own Greek holdings, a private-sector haircut can only go so far toward reducing total debt. As it is, the voluntary write-down is expected to reduce outstanding Greek debt to—this is almost comic—120% of GDP by 2020. This gives new meaning to kicking the can down the road. And that's the best-case scenario.

To prevent the write-down from tanking European banks, the deal provides for a raft of measures for bank recapitalization. One requires euro-zone banks to achieve a 9% capital ratio for core Tier 1 capital by June 2012. The European Banking Authority (EBA) estimates that this amounts to a €106 billion hole for Europe's largest banks to fill. Whether these new capital requirements will do much good remains to be seen. Still fresh in most memories is that Franco-Belgian lender Dexia fully met its own Tier 1 requirements before it went down earlier this month.

Another corner of the bank recapitalization plans is that national governments will increase their own bank guarantees. The EBA's statement notes that these public guarantees are needed to prop up banks "against the backdrop of the increasing concerns regarding sovereign debt." Translation in any language: More government spending and taxpayer guarantees are required to forestall fears that Europe's governments are already in one of history's deepest holes of debt.

That brings us to the summit's last plank, an agreement to pump up the €440 billion European Financial Stability Facility. Details of course will be negotiated later, but the bailout fund is now authorized to act as a bond insurer, guaranteeing first-losses up to an as-yet undecided amount on new issuance of euro-zone sovereign debt.

The legal basis for this is dubious under the Rome Treaty, which explicitly forbids member states from guaranteeing each others' debt. And insurance doesn't come cheap when the sovereigns being insured are the same ones that might be bankrupted by having to pay more into an insurance fund. A first-loss guarantee may reduce the probability of default, but it raises the costs of default if it does happen.

In short, everyone is bailing out everyone. The larger problem betrayed by yesterday's agreement is that European leaders continue to act as if they are mainly dealing with a crisis of confidence, which can be restored with evermore far-reaching bailout schemes. Absent from this week's communiqués are any new ideas for promoting the structural economic reforms—both at the periphery and at the center of the euro zone—that might create real confidence in the euro zone's long-term economic prospects. The new bailout money Greece is getting doesn't even come with new conditions for implementing structural reforms, as the first bailout package did.

Not surprisingly, markets rallied at yesterday's news, with the euro gaining 2.4% against the dollar. That isn't the first time a Brussels summit has triggered a burst of market relief. But without economic growth and more fundamental reform, yesterday's deal will merely be the latest palliative.