European leaders claim to have reached a deal to solve the European debt crisis. This is not the first time they have made such a claim, but there are reasons to be optimistic. Not only is the solutions presented much more extensive then previous measures, markets also seem to have welcomed them. This is important since stock markets have fallen after previous deals to 'save the euro', reflecting their inadequacy. This time around expectations were already high as seen in the healthy growth in equity prices is recent days, still the deal seems to have lived up to those high expectations. As reflected in the subsequent stock market rally.
The deal seems sound in that it supposedly deals with all the negative side effects of a Greek partial default. Which is what the 50% write down of the value of Greek bonds must be seen as. This being a default should in a normal situation trigger insurances agains defaults taken out by many owners. Since it seems very unclear who would have to pay what in such a situation, it could potentially trigger another credit crisis. Luckily this write down is 'voluntary', in order to avoid such default insurances from being valid. Of course no one would voluntarily agree to lowering the dividend on their bonds except under pressure from outside institutions to do so. But what matters is not not if this is a Greek default or not, it obviously is, what matters is if it is classified by such by the bond ratings agencies. And it shouldn't be.
This means the burden of a Greek default will fall mainly on the big owners of such debt. These include big European banks. The failure of which could lead to economic collapse. This problem is supposedly solved by beefing up bank capital so that they can sustain such losses. If the banks can't do it themselves national governments will help, if even they are unable the EFSF, the European bail out found will pick up the tab.
This found will also deal with the third potential problem associated with a Greek default. If Greece is allowed to default then what about other indebted countries? This is the question investors could start to ask, increasing borrowing costs for indebted European countries. The bail out fond was created to solve this problem, by buying bonds if yields rise too high it was supposed to ensure that markets didn't hesitate to lend to debt burdened governments. But it was deemed too small by markets and fears persisted. This problem seemed hard to tackle since the fond was too small to save economics giants such as Spain and Italy, but boosting it further could endanger the belief in the founds creditors ability to pay out such extraordinary sums of money. This seems to have been solved by instead of increasing the found, allowing it to partially compensate investors in case of government defaults. By covering some of their potential losses the bail out found is expected to do much more to keep the costs of governmental borrowing down by decreasing the risk of investing in European bonds.
With all these 'fixes' in place the European economy should be able to handle a big write down of Greek debt and lessen worries surrounding European banks and governmental finances.
