The EU's summit deal--accomplished after the obligatory drama of another all-night session--delighted financial markets. Stock markets surged and Spanish and Italian bond yields subsided, from the crippling to the merely unaffordable. The leaders exceeded expectations and took steps in the right direction--but if they don't do more, and soon, I doubt the joy will last.
The summit's main achievement was to agree in principle that the ESM, the system's rescue fund, could recapitalize distressed banks directly rather than by lending to their governments. Potentially, this is a breakthrough. Direct support takes debt off the books of distressed sovereigns and passes it to the EU. It's a move towards banking union--and indeed it's a kind of fiscal union. Angela Merkel had previously said it wouldn't happen. The recently announced rescue package for Spain flopped because it failed in this very respect: It offered relief to the banks, but at the cost of adding to the Spanish government's debt load. If the summit had produced nothing on this, Europe's keenly awaited Lehman moment would surely have arrived.
It's good news that Merkel has backed down on this vital point. The leaders' statement opens a new and more promising line of EU response to the euro-area's crisis. But for now there's much less here than meets the eye. The leaders' statement says this new form of support won't start until a new EU bank regulator has been created--and the deal on this has only been sketched. All the summit partners have promised to do is start work on it. Since it's a complex and controversial issue, we have further delay at the very least. There's plenty of scope for things to go wrong in the coming negotiations. At worst, we might get no deal at all.