It all sounded so promising. In the early morning hours on Oct. 27, German Chancellor Angela Merkel and French President Nicolas Sarkozy emerged from a day of edge-of-their-seats negotiations and announced a historic plan to pull the continent's economy back from the brink of disaster.
The agreement, acceded to by European governments and the Institute of International Finance, had three parts. Investors -- mostly European banks -- would write off half of the face value of the Greek bonds they held, a particularly toxic ingredient in Europe's debt crisis. The banks would raise capital to the tune of 100 billion euros, removing some of the uncertainty over the shaky sovereign government debt on their books. And the European Financial Stability Facility (EFSF) -- the continent's 625 billion-euro bailout fund -- would be bolstered to 1 trillion euros in order to protect other vulnerable economies from imploding the way Greece's had. The politicians involved patted themselves on the back, and stock exchanges on three continents sharply rallied on the news of a deal, with some European bank stocks leaping by as much as 25 percent in a single day.
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Unfortunately, it didn't take long for the expectations from last week's summit to come crashing down to Earth, and loudly. Putting the pieces back together will not be easy. And the implications are consequential -- not least for the upcoming G-20 meeting, the agenda for which will likely be hijacked by Europe's renewed turmoil.
The markets' initial euphoric reaction was based on a twofold hope. The first was that Europe would quickly translate the agreements into specific and lasting measures. The second was that Europe would address two big issues that were not on the summit's agenda and needed to be: the restoration of economic growth and the strengthening of the institutional underpinnings of the eurozone.
Investors were giving policymakers the benefit of the doubt -- and as it turns out, it only took a few days for markets to realize that, once again, they had placed too much faith in leaders' ability to follow through in a decisive manner. The result has been significant market turmoil as three developments essentially unraveled the summit's achievements.
First, in a surprise move, Greek Prime Minister George Papandreou announced he would hold a national referendum to seek broad-based popular support for the measures agreed upon last week. This baffled other European leaders, who were under the impression that Papandreou and his government had already signed off decisively on the deal. It also cast major uncertainties over the willingness of the European Union and the International Monetary Fund (let alone countries like China) to lend to Greece ahead of the referendum -- which is still pending a vote in Greece' parliament -- thereby increasing the risk that the country could run out of money this month to pay some bills.
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