The euro under control

Thursday's summit in Brussels came up with a number of proposals to combat the financial crisis, all of which are a step in the right direction. The summit laid the ground for another rescue of Greece, as well as the injection of new loans to the tune of 110 billion euros (to be paid by the EU and the IMF). Equally important, the summit saw agreement between EU leaders that the bloc's approach until now for rescuing countries in financial difficulties suffocates any hopes for growth, and that the Financial Stabilization Fund should take a proactive approach.

To achieve all this, the EU seems prepared to lower the cost of help to countries in trouble (interest charged would fall from the current five percent to 3.5 percent). It will also extend the period over which repayments must be made, while allowing the Stabilization Fund to make preventative loans, recapitalize banks, and buy debt on the international markets. The problem is that extending the Fund's functions will need to be approved by all member states' Parliaments — a lengthy process with no guarantees of success.

The deal to restructure Greece's debt will effectively mean cancelling part of it. It is essential that this extension is not blocked by the ratings agencies, with the accompanying risks of default. Sarkozy has said that the EU is temporarily guaranteeing Greek bonds. The ECB president, Jean-Claude Trichet, is still worried that the private sector's losses from the cancellation will damage Europe's financial system.

Sarkozy and Merkel showed common sense in accepting the new role of the Stabilization Fund, which will be key to calming the markets and providing the euro zone with the means to intervene directly and rapidly when a financial crisis erupts. It is to be hoped that Angela Merkel does not oppose this promising measure.

Europe desperately needs institutions that are not only able to organize rapid financial intervention at times of emergency (the ECB cannot act in such cases), which should be understood as a future European stability mechanism, as well as a means of converting the broad brushstrokes of agreements made at summits into smaller commitments that will allow them to be applied between member states.

Enthusiastic greeting

Thedraft outline, which had already been leaked prior to the summit, was greeted enthusiastically by the markets. This enthusiasm was justified if only because Europe's leaders finally appeared to have grasped the nature of a crisis that has transformed doubts about sovereign debt into doubts about sovereign solvency. The draft agreement suggests that the EU is finally on the right track; moreover, it is probably the only track if it is to break this vicious circle. This explains why the risk premium fell to 280 basis points on Thursday in the case of Spain, and to 250 basis points in the case of Italy, as well as why the European markets reacted so positively.

It should be remembered that the summit only addressed guidelines. All that is required are problems in applying these guidelines for the markets to get edgy again. Europe needs institutions to address its financial problems, not deals between France and Germany.