Private investors are being forced to eat losses. In return, they'll demand higher interest rates from Italy and Spain. That makes it more expensive to insure Italian and Spanish debt.
The overnight deal to address the Eurozone debt crisis follows an eerily familiar pattern. Waiting until action was long overdue, Europe's leaders have come up with a solution they will sell as final and complete while leaving important -- and potentially deal killing -- details for later. The markets surged yesterday on the news of what appears to be a massive deal. But if past is prologue, it will slowly become apparent that Europe has solved few of its underlying problems, and another round of this seemingly endless game will come later.
The important steps that were taken came months after the need was obvious. The deal covered three main areas, each of which has some potentially fatal flaws:
Shoring up Europe's banks: Key banks are being forced to recapitalize by raising €106 billion (roughly $150 billion) in new capital. While this is less than most analysts believe is needed, it's nonetheless a real step towards fixing a problem. But this was essentially going to happen with Basel III anyway. This wasn't a new policy, but an expedited policy. The big question is where the recapitalization funds will come from. Based on precedent, taxpayers will foot a large part of the bill. How this plays in French and German politics will have a big impact on its success. So far, that argument has not gone well for President Sarkozy, and has been even worse for Chancellor Merkel.