All right, we’ll give investors this much: They keep track of politics and pumped hopeful oxygen into the dull, lifeless saga of horse trading and electoral survival that is taking place on Brussels’ scene. A little swing upwards by the markets, and our spirits rise. Maybe this time European Council leaders have reached something substantial, perhaps even the outlines for a solution to our problems. A few days later, however, and those same investors will find their feet as firm on the ground as before, passing the sceptre back to pessimism and our merry-go-round starts again. The European Council lead to no more than vague agreements and obscure terminology.

European leaders seem to have real issues with terminology and definitions. Our philosophical history is scattered with texts by (mostly) men who invented terms for the sole sake of abusing them, but language is not something one bends or breaks at will, dear leaders. Voluntarily participating in writing off debt? Possible, up to a certain point. Yet the infamous saying that there is ‘no such thing as a free lunch’ might make one wander at the 50% haircut private investors are facing, simply because the untested Credit Default Swap market might unleash panic in the markets.

In no other situation would the word ‘voluntary’ have ever popped up so many articles, documents, debates and government decisions. Since when do private investors voluntarily give up money? For years I have been taught that evolution is a process of gradual change over many generations, but European leaders seemed to have found a shortcut for Homo Economicus, a species that went from self-indulgent to near-altruism in less than a decade.

It is a pity that their political careers do not evolve according to such rapid principles. Besides the unavoidable claims we’ll be facing that writing down 50% of Greece’s debt is a default, European leaders have missed a few essential points in their deliberations. The European Financial Stability Facility should be the biggest of our worries, even though it is Greece that suffers the displeasure of every tax-payer who anticipates his money ending up in Greek retirements. The size of its economy makes it only a minor worry compared with Spain, Portugal and Italy, which are the true culprits behind the EFSF’s presence.

Heeding calls from the economists, government leaders have decided to prop up the bail-out mechanism to a potential one trillion Euro weapon. Sadly, potential is a key word. Northern European countries are unwilling to invest more money, hence they came up with two schemes to stretch the EFSF:

 … One is to use it to insure the first losses if any new bonds are written down. In theory, this means that the rescue fund’s power could be magnified several times. But in practice, such “credit enhancement” may not yield much. Bond markets may be suspicious of guarantees made by countries that would themselves be vulnerable if their over-indebted neighbours suffered turmoil. 

Under the second scheme, the EFSF would create a set of special-purpose vehicles financed by other investors, including sovereign-wealth funds. Again, there are reasons to doubt whether this will work. Each vehicle seems to be dedicated to a single country, so risk is not spread. And why should China or Brazil invest a lot in them when Germany is holding back from putting in more money? (http://www.economist.com/node/21534849)

It is ironic to see how European governments are trying to use financial instruments that might disappear in thin air. Credit enhancement will prove to be little more than good old fashioned, pre-financial crisis derivatives. And derivatives were the bane of the financial crisis. And so it turns out that the European Financial Stability Facility is unlikely to lead to stability, the result from underestimating the dangers coming from Italy and Spain, two countries that are (1) too big to save if the EFSF is not increased to at least 1.5 trillion Euros via legit ways, i.e. not by trying to cheat on the markets by fancy terminology and (2) a risk for an already precarious stack of problems that might speed up France’s imminent downgrading, which will have a strong effect on the market’s perception of the EFSF, an instrument that relies heavily on government’s ability to lend at cheap rates.

The second option is an astounding act of cowardice. As with ‘voluntarily’ writing off debt, the EU now turns to the global market that cannot do without a strong Euro. This rather ironic proposal needs not be cast away without second thought, but there are some restraints if our leaders opt for this route. The first is that that China, as one of the potential biggest investors, might be unwilling to invest in the Euro as long as the Northern European countries are averse to do so. Second, neither China nor Brazil or Russia would channel money to European countries by directly buying government bonds; rather they would use the IMF as an instrument (while making sure they gain in influence).

Most incongruous of all, instead doing what must be done, we wait, debate, postpone and invent de-tours. De-tours that involve potential rescues by oppressive regimes. Yes, European leaders have decided that banks need to increase their core capital, but it will not make a difference if the EU does not ringfence Spain and Italy from default and as long as uncertainty  reigns Greece’s future.

Angela Merkel tried to temper the public’s expectations prior to the Council meeting. She failed. The question is whether you should be willing to temper expectations for such a lengthy period. The Council has postponed every measure on further economic integration, trying to satisfy its citizens by noting that ‘an interim report will be presented in December 2011′. Can’t wait.