Will the EU’s $1 trillion-plus package take the global financial system off the brink?  Initial market signs are encouraging, but far from dispositive:  to know for sure that panic has been allayed, we want to see inter-bank funding markets thaw and rates return to reasonable ranges.  But, even if that happens – as we devoutly hope – it won’t take the global banking system back to a semblance of normalcy because of the exposures at giant banks to sovereign debt.  Unless the EU and ECB support facilities take trading prices up to prior ranges – which they won’t – banks holding EU sovereign debt will need to recognize large losses they can ill afford.

The reason:  sovereign debt and bank-issued debt from troubled nations isn’t buried in the bowels of “level 3.”  That’s the accounting hidey-hole that allowed banks and other large holders of subprime MBS to argue at the height of that crisis that all of their woes arose from mark-to-market accounting, not the genuine solvency problems bedeviling these high-risk holdings.  Sovereign and bank debt is readily-traded, highly-marketable – that’s why it gets all the capital, liquidity and investment benefits that contribute to such huge holdings.  As a result, valuation losses track right through on both the trading and banking books of every large sovereign and bank-debt holder.

That the risk may be short-term and markets will stabilize with the new guarantees is possible, but even short-term valuation losses translate into immediate hits to the bottom line.  This, in turn, brings markets right back to fright, if not panic.

So, while the Monday announcement suspends systemic risk, it doesn’t take it away – nor could it.  Underlying all of the weak instruments is more than a liquidity crisis, it’s same-old, same-old solvency problems, now translated from subprime mortgages to sovereign risk.

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