One scenario for the eurozone

Not a prediction, but I have been thinking through one possible path.  Germany supports a phased-in backstop of eurozone bank deposits, but with intermediate goals and targets along the way.  They’re not simply going to write a blank check.  Some of the goals and targets are fiscal, while others involve turning over bank supervision to the EU.  Obviously, none of this can be done quickly, thus there is no immediate done deal, but it might calm the markets.  Germany also requires that Spain commit “the Irish mistake,” namely guaranteeing the returns to bondholders and funding that guarantee through “austerity.”  Since Germany would also be backstopping Italy, France, and others, it doesn’t want a bondholder run, even if Spain, taken alone, might be better off forcing the bondholders to take losses.

Spain will claim it accepts the agreement, but in fact it won’t.  It won’t over time, and it won’t pledge up front to fully protect the bondholders.  Spain wants to see the money first.  Capital flight continues and eventually intensifies.  The deal does not get made in time and arguably there was no deal there in the first place, since Spain never had the willingness, or perhaps not even the ability, to meet the intermediate targets along the way.

One current option for Spain is to announce preemptively that it will accept significant EU supervision for their banks, with or without a broader deal.  Arguably this would help ease their way into an agreement with Germany.  In fact they are doing the opposite, by playing to the domestic audience and stonewalling on transparency about the nature and extent of their banking problems.