Mario Draghi sees reason to be “optimistic” about the euro-areafinancial crisis now that he's committed the European CentralBank's balance sheet to ending it.

That confidence depends on political leaders who have rarelymissed an opportunity to miss an opportunity since Greece's 2009deficit blowout began upending the 17-nation euro zone. Their trackrecord and the compromises required to put their promises intoaction leave Juergen Michels, chief euro-area economist atCitigroup Inc. in London, skeptical.

“There are still a huge amount of unanswered questions and theregion has to find a way back to growth and reduced debt,” saidMichels. “The journey is still very, very long.”

Time has been bought by ECB President Draghi's pledge topurchase government securities and the imminent birth of Europe's500 billion-euro ($653 billion) bailout fund, the EuropeanStability Mechanism. To persuade global investors that the euroarea can make it through its second decade intact, Frenchsocialists, German burghers, Catalan separatists, Italiantechnocrats and Greek tax collectors have to forge a rainbowalliance to meet the conditions demanded by markets, creditors andthe ECB.

Following an unproductive meeting of European finance chiefs inCyprus last week, a market rally triggered by Draghi's debt-buyingplan has run out of steam. Spanish and Italian bonds havesurrendered some of their recent gains.

Spanish 10-year yields reached a euro-era record 7.75 percent onJuly 25, before Draghi pledged a day later to do “whatever ittakes” to safeguard the monetary union. Since then, they havefallen below 6 percent, while those of Italy have dropped more thana percentage point toward 5 percent. The euro has gained 7 percentagainst the dollar since the start of August.

“Politicians tend to act for their own good and that of theircountries rather than the greater good of Europe,” said JacquesCailloux, chief European economist at Nomura International Plc inLondon. “That's an unfortunate case and if it continues the marketswill test the sovereigns again.”

Unresolved is whether Spanish Prime Minister Mariano Rajoy willtrigger the ECB's aid-for-austerity deal and if Greek leaderAntonis Samaras keep his constituents, coalition partners andbenefactors onside enough to keep aid cash flowing.

Looming is the vulnerability of Italy and the fragility ofunelected Premier Mario Monti's coalition as Cyprus negotiates thefifth bailout after Greece, Ireland, Portugal and Spain's financialsystem.

Outside the danger zone, German Chancellor Angela Merkel mustrally her bailout-allergic electorate and French President FrancoisHollande needs to recast his growth-model. Meantime, Europeanpolicy makers are struggling to meet a self-imposed deadline of thestart of 2013 to get a bank-supervisory regime up and running.Merkel and Hollande are scheduled to meet Sept. 22 Ludwigsburg,near Stuttgart.

Crisis aside, they all share the urgency of finding an economicelixir. Unemployment is at a record 11.3 percent in the euro blocand as high as 25 percent in Spain. The region is bound for itssecond recession in three years.

“The region has to get down to the messy business ofimplementation, and is likely to throw up problems along the way,”said Alex White, an economist at JPMorgan Chase & Co. inLondon.

Europe's powers are, for now, enjoying a moment of calm afterthe ECB revived bond buying, Germany's constitutional court blessedthe ESM, an election in the Netherlands passed without an anti-eurospasm and Greece's prospects for help stayed intact despite budgetbacksliding.

“Europe is stabilized,” Austrian Finance Minister Maria Fektersays. French Finance Minister Pierre Moscovici sees “light at theend of the tunnel.”

The lesson of the turmoil is nevertheless that pride has alwayscome before a fall. Leaders declared a turning point six months agobefore hitting reverse as Spain's banks wobbled and support forGreek anti-bailout parties forced two elections there in a six-weekspan. In 2011, officials cheered the results of a July summit andheaded on vacation only to find their pact in pieces before theyreturned.

The respite in markets won't “last long” if Spain doesn't seekassistance, ECB Governing Council member Luc Coene said Sept. 17.“Spreads will rise again, and then Spain will be somewhat forced tocome back on its decision and submit to the conditionalityprogram,” he said.

Rajoy's Delay

Delay is the order of the day in Madrid. Rajoy, in power for 10months after winning the biggest parliamentary majority in almostthree decades, is balancing the need for aid with the potential forpolitical and economic fallout.

He has already reneged on promises not to cut firing costs orunemployment benefits, raise taxes and scrap a tax break onmortgages. The leader of Catalonia, which accounts for 20 percentof the country's economy, raised the specter of secession even ashe clings to a financial lifeline from Madrid.

“An imminent application for external assistance by thegovernment is unlikely,” said Antonio Barroso, an analyst at theEurasia Group in London. “Rajoy's priority is to limit the numberof conditions attached to another rescue package and thereby limitthe negative political spillover from accepting additional externalaid.”

Rajoy is first trying to pacify markets by promising to detailnew reform measures by the end of this month, including a possibleincrease in the retirement age, shift toward consumption taxes andderegulation of closed professions. If that's not enough, he willhave to decide on the size of a bailout, with Germany advisingagainst a full rescue given he has already secured 100 billioneuros for banks.

The more Spain digs in its heels, the more Germany may seekharsher terms, said Andrew Benito, an economist at Goldman SachsGroup Inc. While Germany's top court backed the ESM and Merkelendorsed Draghi's Outright Monetary Transactions over theresistance of Bundesbank President Jens Weidmann, her public isless sympathetic.

Their views — reflected in an ARD-DeutschlandTrend poll thatshowed just 13 percent supported ECB bond-buying — will countincreasingly as Merkel gears up for re-election next year.

“The more the Spanish administration indulges domestic politicalinterests and is perceived to be taking undue advantage of externalsupport, the more explicit conditionality is likely to bedemanded,” said Benito. “This would add to existing tensions.”

The risk of German antagonism could leave the ECB in a tightspot if a bailed-out country then falls short of what's demanded.The Washington-based Institute of International Finance, whichrepresents more than 450 financial companies, this week warned of a“cliff effect” in which termination of support prompts an “abrupt”market correction.

In another squabble that could delay a lasting solution, Germanyis pushing back against the timetable for greater bankingoversight, urging caution when assigning new duties to the ECB.European Union leaders want a single supervisor by the start ofnext year to break the negative feedback loop between sovereign andbanking debt.

That spat foreshadows a deeper divide as the bloc's leaders turnto closer cooperation on budget issues. “We've made little progresson fiscal union, and that will be the next focus,” said JoachimFels, chief economist at Morgan Stanley in London.

If Spain does hit the aid button, attention would shift to Romewhere officials so far deny the need for help even as anausterity-driven recession deepens. Monti is now overhauling thelabor market by easing the rules on firing workers during difficulteconomic times without the risk of a court ordering theirreinstatement. Support for the government fell to a low of 17percent, a poll by Rome-based IPR Marketing showed Sept. 17.

The need to quell a “contagion effect” will likely leave Italyunder pressure from governments and investors to sign up for helpif Spain does, said Tobias Blattner, director of European economicresearch at Daiwa Capital Markets in London.

Europe's original problem child, Greece's three-way coalitiongovernment is still trying to win aid blocked since June. It hasyet to to agree on a full package of 11.5 billion euros of savingsin the next two years.

“You want to be sure if something happens to Greece, you wantSpain and Italy under the umbrella,” Blattner told Mark Barton onBloomberg Television's “Countdown.”

Greek Verdict

While late homework has typically meant punishment, Greece iswinning some respite and may get easier terms as Europe's chiefstry to cement the market rally and keep from reheating theeuro-exit trade. A verdict on the country's fiscal plans will nowwait until October when European leaders next gather.

Even if the next chunk of a 240 billion-euro package is releasedthere remains a funding gap unlikely to be cut by fiscal measuresamid a fifth year of recession, says Erik Nielsen, chief globaleconomist at UniCredit SpA in London.

“My bottom line is that Greece will remain in limbo, drip-fed byEurope and the IMF during the next six to 12 months, and thatcrunch time is more likely to start next year,” said Nielsen.

Longer-term, Jennifer McKeown of London-based Capital EconomicsLtd. warns it's too soon to “sound the all clear.” Europe may stillfind its financial firewall too small and while bond-buying dealswith the symptoms of the euro's ills it doesn't tackleunsustainable debts and how to cut them without deflatingeconomies, she said.

“Our long held view that a limited euro-zone break up willcommence in the coming months is unaltered,” said McKeown.

Bloomberg News

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