Europe: Sputtering toward oblivion

July 2, 2012: 11:44 AM ET

The eurozone crisis at an end right? Not a chance.

By Cyrus Sanati, contributor

FORTUNE -- European leaders continue to apply flimsy Band-Aids to their gushing economic wounds in an effort to avoid making the hard decisions necessary to save the euro from oblivion. The 19th "emergency" EU summit to be called since the European debt crisis began over two years ago concluded on Friday with yet another sputtering salvo of stop-gap measures and shaky promises. There was little, if any, talk of tackling the structural problems behind the crisis, with leaders still at odds over how they will philosophically go about solving the issue.

Kicking the can down the road to buy some time may have sufficed at, say, the third or fourth summit, but doing so this deep in the crisis is simply inappropriate. While markets may rally in the short-term, they won't be back to normal until it is certain that Europe is on the right track.

The resolutions reached at the conference Friday centered primarily on preventing Spain, and to a certain extent, Italy, from needing a potentially disastrous sovereign bailout. The belief was that if either of the two countries even whispered the words "default" or "haircut" then the euro could come crashing down as investor confidence dried up. To avoid such an outcome, EU leaders made a few sizable tweaks to some of the bailout rules they had just months ago painstakingly hashed out with one another at one of the various other "emergency" summits.

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The first big change agreed to at the conference was that the money from the big bailout funds, the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF), could now be used to bailout the eurozone's troubled banks. This change was primarily aimed at helping Spain as its banks have become starved for capital. Before this change, the funds were only authorized to bailout eurozone governments through the purchase of their sovereign debt. This therefore avoids the need for the Spanish government to borrow money on behalf of its banks.

The second major breakthrough reached at the conference centered solely on Spain. With much reservation from Germany, it was agreed that the debt issued by the bailout funds would not be "subordinate" to Spain's sovereign debt. That means if Spain for some reason ends up defaulting on its debts, then Spanish bondholders wouldn't have to wait for the bailout bonds to be paid in full before they saw some relief. This cleared up the question of seniority in the payout structure, which was one of the big reasons why investors were shunning Spanish debt and driving up their yields to unsustainably high levels.

Lastly, member states agreed that there should be a common bank supervisor for the Eurozone in order to harmonize rules and regulations across the continent. The European Commission is now planning a draft proposal for the a mega banking bureaucracy with a goal of implementation by the end of 2013. EU leaders noted in a statement released after the meeting that this new pan-EU banking supervision would "break the vicious circle between banks and sovereigns."

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The markets rallied Friday and continued strong through the weekend following news of the conference and its outcome. Spanish 10-year bond yields plunged 62 points on Friday to 6.32% while Italian yields fell 38 points to 5.81%. Those levels were holding in early Monday morning trading, which has made some euroskeptics question their positions.

So is the eurozone crisis at an end? Not a chance. The market usually rallies hard following one of these conferences only to fall back once reality sinks in. The agreements struck at the conference were not terribly impressive and were very short-sighted. It is similar to a person who chooses to stomp out the fire around their feet instead of grabbing the hose to douse the raging inferno headed their way.

To be fair, some of the resolutions reached on Friday could have a positive impact on the crisis, such as saving Spain from having to take on a lot of debt to save its crippled banks. The question is -- how long can this honeymoon last? Spain's weak economy will continue to make long-term investing in the country problematic. With 25% unemployment, Spain's key bond yields will be elevated indefinitely if not addressed. Furthermore, some of the resolutions could have some unintended consequences. For example, by downgrading the bailout bond's seniority, EU leaders are jeopardizing its credit rating, which could push up yields and drain the fund at a faster clip.

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EU leaders hinted for weeks that this latest summit -- number 19 -- wouldn't just be another triage session. It would be here where EU leaders really got serious and began discussing the structural issues that has paralyzed Europe's economy for 30 months and counting. But those discussions didn't happen. There was no agreement to form a closer fiscal union across the eurozone, as championed by Germany, nor was their talk about issuing a common debt instrument (Eurobonds), as championed by France. There were some vague promises made to construct a study on both of these major issues, but it wouldn't be ready until October. The Eurozone may not make it till then.

So what's next on the agenda? It's now up to the bond market to push EU leaders out of their complacency and into action. While yields have fallen on Spanish and Italian bonds, they will almost certainly pop back up due to their weak economies. But this crisis is dangerous as the market has shown that it can skip around and attack different countries at different times for any number of reasons. With France about to implement a number of socialist policies, the market could turn on Paris in a flash. Germany, with its 90% debt-to-GDP ratio, is no angel, either. If investors begin to feel that the Eurozone situation is hopeless, forget Spain, not even the German Bund will be safe from attack.

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