Two years into their debt crisis, eurozone leaders agreed Friday for the first time to deploy their firepower without also shooting themselves in the foot.
In a sudden reversal of a move that backfired three weeks earlier, Germany appeared to cave on its insistence that Spain bear the liability for $125 billion in bailout funds to recapitalize its banks.
In dumping an extra debt load of about 10% of GDP on its rescue victim, that bailout had only brought Spain closer to insolvency. Friday's move brought Spain back from the brink — for now.
Global markets cheered the new eurozone commitment "to break the vicious circle between banks and sovereigns.
Spain's 10-year yield dived to 6.38% from nearly 7% Thursday. Spanish and Italian stock indexes soared 6% and 7%, respectively.
In the U.S., the S&P 500 rose 2.5% and the Nasdaq 3% to their best levels since early May.
The summit of eurozone leaders in Brussels also produced agreement on a few other measures to stem the crisis and combat the deepening recession. Terms under which the new eurozone bailout fund (the European Stability Mechanism) could intervene in sovereign debt markets were made less punitive. They also signed off, as expected, on stimulus equal to $150 billion, or 1% of GDP.
But while this summit offered a ray of hope that the days of self-defeating bailouts could be over, those new crisis resources won't go very far.
Together, the ESM and European Financial Stabilization Facility have about $500 billion in firepower — excluding the funds expected to go to Spanish banks.
Spain and Italy have about $3 trillion in sovereign debt, so there is a limit to how much current resources could hold down borrowing costs before they run out.
"Italy doesn't plan to activate the mechanism for now, but I don't exclude anything for the future," Prime Minister Mario Monti said.
The implication was that having bailout funds available to buy Italian debt might avert the need to do so. But with the eurozone in recession, debt levels still rising and no end to the crisis in sight, that may be wishful thinking.
"Markets will also need some commitment that member states with high public debt levels could eventually (say, in a couple of years) receive further significant support from others, such as through a debt redemption fund," Barclays economists wrote.
Such measures involving a trade of financial support from Germany in exchange for transfers of fiscal sovereignty to Brussels will likely require individual countries to change constitutions and hold referenda.
Further, there remains much uncertainty as to how Friday's agreement on bank recapitalizations will work in practice.
German Chancellor Angela Merkel seemed on her way late Friday to winning parliamentary approval of the ESM after insisting that she hadn't agreed to any additional potential liabilities at the latest summit.
But the new measures will require German lawmakers' OK — once they are clarified.
Merkel said it may take up to a year before a zone-wide bank regulator is in place and direct bank recapitalizations by the ESM become a reality. Still unclear is whether Spain could have some contingent liability if its banks default on bailout loans.
Reuters reported Merkel as saying finance ministers would have to work out whether the state or the banks would be legally responsible for repayment.