How long will markets' EU-phoria last?

German Chancellor Angela Merkel speaks during a media conference at an EU Summit in Brussels on Friday, June 29, 2012. European leaders have agreed to use the continent's permanent bailout fund to recapitalize struggling banks, and agreed to the idea of a tighter union in the long term. (AP Photo/Michel Euler)
Michel Euler

(MoneyWatch) Can the markets' euphoria over the EU's rescue plan last? The agreement announced last night to make direct bailout loans to banks still has a long way to go to be enacted and still doesn't address the underlying sovereign debt crisis. While the European Union leaders have bought themselves some more time, it is far from clear if it is anywhere near enough time to deal with the problems Europe faces.

The leaders of Spain, Germany, Italy and France have agreed that the EU's still-in-the-works permanent bailout fund can put money directly into the banks. This means the national governments will not have to repay those funds if the banks default. This will effectively make the European Central Bank overseer of Spanish banks and those of other EU countries. The bailout fund, known as the European Stability Mechanism (ESM), is expected to be up and running by the end of the year.

The leaders also agreed to let governments have access to rescue loans without having to relinquish control of their economies. This means that if Spain or other nations need funds they would not have to adhere to the draconian budget requirements imposed on Greece, Portugal, and Ireland over the past two years.

This news sent stock markets up and, more importantly, caused a marked fall in the amount of interest Spain and Italy are being charged in order to borrow money. At the end of trading in Europe Friday the Spanish 10-year bond was down nearly a half point to 6.4 percent and the 5-year bonds were down more than a point to 4.47 percent, their lowest level in more than a month. Italy's 5- and 10-year bonds closed down at 5.2 percent and 5.8 percent respectively.

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The question now is will investor confidence hold up even with so many questions unanswered and so many details still be worked out?

While the deal removes the problem of Spain having to borrow more to save its banks, it does nothing to address the nation's other overwhelming debt problems. A huge recession already had the national government struggling to pay its growing debts and that was without the added burden of huge amounts of money owed by the nation's regional governments. Spain's national government budget deficit was targeted at 3.5 percent for the entire year and at the end of May it was already at 3.4 percent. This amount does not include debt from the regional governments.

There is also the very real question of whether or not the ESM will have enough money to do all the things it is going to be asked to do: Support the Italian bond market, the Spanish banking sector, and the Spanish state.

Previous estimates of the amount of money the ESM would have included donations from nations like Spain, that are actually not able to provide funds. Also, it will be called on to make loans to insolvent banks and cannot expect to be repaid by them anytime soon. On Thursday, three external appraisers put the value of Bankia, Spain's fourth largest bank, at negative $17 billion. There are many more such bank appraisals still to come.

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