By Mark Whitehouse
Europe's latest plan to end its sovereign-debt crisis has generated a lot less euphoria in credit markets than in stocks. That's not a good sign for European leaders who are hoping they've crafted a final solution.
The Euro Stoxx index of 50 blue-chip companies rose more than 5 percent after the announcement of the deal. As Bloomberg View has noted, the plan seeks to restore confidence in three ways: Boost the capacity of the euro area's rescue fund to about 1 trillion euros, require private creditors to write down Greece's debt by 50 percent and push banks to raise the capital needed to absorb sovereign-debt losses.
Bond investors, for their part, weren't much impressed, as is evident in the borrowing costs of vulnerable governments. The yield on Italy's 10-year bonds stood at 5.87 percent today, slightly down from 5.93 percent yesterday but still very close to a euro-era high. France's 10-year yield rose to 3.13 percent, from 3.07 yesterday.
Meanwhile, key gauges of the banking sector's health showed little sign of improvement. The three-month Euribor-OIS spread, which tracks the difference between the expected central-bank interest-rate target and the rates at which banks offer to lend euros to one another, narrowed by only 0.01 percentage point to 0.77 percentage point -- still well above its mid-June level of 0.20. Similarly, the dollar-based Libor-OIS spread shrank by a tiny 0.005 percentage point.
The underwhelming reaction reflects some serious shortcomings in Europe's plan. For one, even 1 trillion euros is not nearly enough to cover the borrowing needs of Greece, Portugal, Ireland, Spain, Italy, France and Belgium, which amount to more than 2.5 trillion euros through 2015. Private creditors' 50-percent writedown for Greece will actually reduce the government's burden by much less than 50 percent, because a large part of the debt is held by official institutions -- such as the European Central Bank and the International Monetary Fund -- that won’t participate in the deal. Finally, the European Banking Authority's estimate of banks' capital needs, at 106 billion euros, is less than half what the IMF and other analysts have estimated.
Europe's leaders deserve credit for recognizing that Greece can’t afford to pay its debts, and that a lot more must be done to prevent market turmoil from destroying the finances of otherwise solvent governments. But the crisis doesn't look to be over.
(Mark Whitehouse is a member of the Bloomberg View editorial board)-0- Oct/27/2011 18:08 GMT