The 3 Key Pieces In The Big Europe Deal

There are three main pieces to today's big Europe deal. Each piece is significant, but there are some big caveats that point to the deep, long-term problems Europe still faces. Here's a quick overview.

1. Greek debt is cut — but will remain super high

Private bondholders will take a 50 percent loss on the face value of Greek debt. This new, bigger cut means that Greece's debt-to-GDP ratio is projected to decline to 120 percent by 2020. That's far lower than where it is today, but it's still super high. Salient example: Italy's debt-to-GDP ratio right now is 120 percent — and that's widely perceived to be unsustainably high.

2. Banks need to increase their safety cushions — but may reduce lending

Banks will need to add 106 billion euros (about $147 billion) to their safety cushions under new rules, according to a preliminary estimate from Europe's bank regulator. This will probably improve confidence in Europe's banks and may halt the slow-motion bank run that's been going on for months now.

But the size of the required safety cushion for each bank is based on the volume of loans the bank has made. So banks may cut back on lending in order to make it easier reach the new targets ("shrink their way to compliance," as the FT puts it). This could make Europe's already slow economic growth even slower.

3. Europe's bailout fund will get more powerful — but will rely on more financial engineering, rather than more government backing

The European bailout fund is borrowed money. Basically, all of the euro zone gets together and collectively takes out loans, then lends that money on to the countries that need it.

Now European leaders want to make the fund go further, mostly so they can use it to protect Italy. But they don't want to borrow more money. There are two ideas for making the fund more powerful without expanding its size. Both have the ring of pre-crisis financial engineering.

First idea: The fund will provide insurance for people who buy government debt. So if you buy, say, Italian bonds, you can also buy insurance from Europe's bailout fund that will make up a chunk of your losses if Italy can't pay back the loan.

Second idea: Create a "special purpose vehicle" that would borrow more money from outside investors in order to support the bonds of troubled European countries. Who would want put up money for this sort of thing? Sarkozy has already put in a call to Hu Jintao.