-- Stocks soared Wednesday after six major central banks agreed to aid European banks, an effort designed to stimulate economic growth in Europe and prevent its debt crisis from unhinging the global economy.
But Europe's woes will continue to rattle U.S. markets — and threaten the fragile U.S. economic recovery — until the euro crisis is settled.
"It buys time. It keeps credit flowing. And it averts a European banking crisis — for now," says Andrew Busch, global currency and public policy strategist at BMO Capital Markets.
Just how much time the central banks are buying is an open question. A European Union summit is scheduled next Thursday and Friday in Brussels to try to fix a debt crisis that began two years ago in Greece and is now spreading to countries with stronger finances.
"We are now entering the critical period of 10 days to complete and conclude the crisis response of the European Union," EU Monetary Affairs Commissioner Olli Rehn said. "There is no one single silver bullet that will get us out of this crisis."
The crisis that central banks are trying to contain: Banks and lenders, fearing that they would not get paid back, have cut off the cash spigot to European banks, which are hobbled by their massive holdings in eurozone government debt. U.S.-based money market funds, for example, have severely cut back on their financing of European banks.
As loans to European banks have dried up, so has their ability to lend and keep the European economy going. The nightmare scenario: a meltdown like the collapse of Lehman Bros. in 2008. That, in turn, could push Europe deeper into recession and force the abandonment of the euro, which could put further pressure on the U.S. economy.
The Federal Reserve, coordinating with the Bank of England, the European Central Bank (ECB), the Bank of Japan, the Bank of Canada and the Swiss national bank, reduced the cost of short-term dollar loans to banks, called liquidity swaps, by a half percentage point starting Monday
The central banks' move ensures that European banks will be able to borrow dollars from their own central banks and continue to lend to households and businesses. "The key here is that all the governments understand that they need to provide the banking system with funds to operate," says Gary Motyl, chief investment officer of Templeton Global Equity Group.
U.S. investors sent the Dow Jones industrial average up 490.05 points, or 4.2%, its seventh-best point gain ever, and its biggest rise since March 2009.
The German DAX index leaped nearly 5%.
"Finally, global action!" said Busch. "This is an important step. It shows the world can work in unison to address the global funding issue."
Absent Europe's troubles, the U.S. stock market would probably be higher than it is now. Interest rates are low, the economy is growing, and corporate profits are robust. Private employers added 206,000 workers in November, more than economists had expected, ADP Employer Services reported Wednesday. And in a surprise move, China eased banks' reserve requirements to stimulate its economy.
But many investment professionals warned that the eurozone crisis is far from over.
"Europe is still in crisis-containment mode, not crisis-resolution mode," says Samy Muaddi, vice president at T. Rowe Price. "We still have the same concerns we did yesterday."
Pressure in the European debt markets has been building for months. Dexia Bank, a European bank with $200 billion in assets, failed in October because it lost access to short-term borrowing.
On Nov. 23, the German government was unable to sell all the bonds it offered for sale. The Bundesbank, the German national bank, had to step in and buy the unsold bonds. On Tuesday, Standard & Poor's cut the credit ratings of some of Europe's largest banks, along with those of some U.S. banks.
Europe's deepening debt crisis has caused borrowing costs for countries to rise, making it more expensive to raise funds and more difficult for them to repay their debts. That toxic combination boosts the odds of a default if access to cheap funds becomes impossible.
For instance, the yield on Italy's 19-year government bond was 7.02% on Wednesday. While that is far below its Nov. 9 intraday high of 7.48%, economists still consider it unsustainable.
Those rates are for borrowers who can get loans. Since May, French banks have lost about $110 billion in short-term dollar lending from money market funds — almost a 50% decline.
Among Wall Street's concerns about Europe are:
•PIIGS. The weakest of the 17 nations using the euro — Portugal, Ireland, Italy, Greece and Spain — issued far too much debt, and investors now question their ability to repay it. A Greek default seems inevitable. "There must be an orderly restructuring and default of Greek debt," says Jamie Stuttard, portfolio manager for Fidelity Investments.
•Solvency. The central banks' move Wednesday made it easier for European banks to get dollar-denominated loans. Now those banks have to shore up their balance sheets and increase capital requirements — fortifying the buffer they have against losses. That could take a long time. Banks will have to sell assets or raise equity to increase their capital.
•Politics. The eurozone has to agree on what to do with its weaker members. "There's no sense in recapitalizing the banks and then having Italy default," Stuttard says.
That's the hard part. Under the current eurozone agreement, each country handles its own spending and taxation.
Countries such as France and Germany, which have relatively healthy ratios of debt to gross domestic product, resent having to bail out weaker eurozone members.
Germany especially takes a hard line against excessive borrowing and against allowing the ECB to intervene to keep down interest rates on the bonds of eurozone countries. The notion of floating eurozone debt, backed by all member countries, is also unpopular in the healthier nations, which assume that they would be left on the hook for paying those bonds.
Pan-European solutions to the crisis have only been partly successful. For example, the European Financial Stability Facility, a bailout fund for troubled eurozone members, aimed to raise 1 trillion euros ($1.3 trillion). It has raised 440 billion ($592 billion) so far.
"The fundamental problem within the eurozone remains the same," says Barry Bosworth, a fiscal and monetary policy expert at the Brookings Institution. "They do not have adequate money in the form of a reserve to be able to ensure the debt of Italy against a run."
"If you look at the coordinated action by the global central banks today, I think the ECB will have to take a more prominent role in the crisis management," said Carsten Brzeski, chief economist at ING financial group in Brussels.
"Right now if you look at the markets, central banks are the only institutions that can restore confidence. Politicians can't. So I think there has to be a bigger role for the ECB in the firefighting."
There are some positive signs. The European Central Bank is indicating it may be ready soon to step up its purchases of eurozone nations' bonds.
The International Monetary Fund, which participated in the bailouts of Greece, Ireland, and Portugal, is preparing to offer more resources, most likely in the form of loans from developing nations.
Few people expect everything to be sorted out in 10 days. But the coordinated move by central banks clearly cheered the financial markets. "It's always good to see global central bank policy coordination," Stuttard says. "We'd love to see more policy coordination in the eurozone."
And as long as Europe makes progress, the world markets will probably remain happy, Motyl says. "They want to see that steps are being taken that will eventually lead to a sounder fiscal policy," he says.