February 16, 2011
The markets may be getting ahead of themselves over the prospects for an end to the euro zone crisis—judging by the performance so far this year of the bank sector; the European bank equity index is up 17%; credit default swaps on subordinated bank debt—a pretty good barometer of market expectations of distress—has rallied by almost a third and senior bank bond yields have fallen. That's quite a vote of confidence in the healing powers of euro zone policy makers.
Sure, it's welcome news that euro-zone governments seem to have agreed to double the size of the European Stability Mechanism, the new permanent sovereign debt crisis resolution facility due to come into being in 2013, to €500 billion ($674 billion). Perhaps they will increase the size of the existing European Financial Stability Fund too, helping to reassure the markets that the euro zone could support both Spain and Portugal if they ran into funding difficulties. But these proposals only address one of the four interlocking problems that lie at the heart of the euro crisis: it is not enough for governments simply to offer funding for stressed sovereign, any "grand bargain" must also addresses bank funding, bank capital and also sovereign solvency.
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