Europe's sticky wicket

A copy of British top-selling tabloid the day after European leaders hashed out a deal to resolve the debt crisis that was soundly rejected by the UK.

Douglas J. Elliott, who worked as an investment banker for two decades, is a fellow at the Brookings Institution.

There has been a lot of sparring coming out of the recent European Summit that was supposed to produce, for the fifth time, a comprehensive solution to the Euro crisis.

These disagreements have disturbed financial markets and made it all the more likely that there will be a market panic in the next few months.

That panic would force leaders to finally back up their words with the money necessary to restore stability, or face quite dire consequences.

I continue to think there is about a three in four chance that the leaders will eventually stare reality in the face and do what is necessary, but that still leaves a worrisome one in four possibility of a disaster that would spread across the globe.

The most important fight in the near-term is the one that is being conducted most subtly.

The European Central Bank needs to be prepared to buy massive quantities of Italian and Spanish bonds if those nations are threatened with loss of access to private funding at acceptable rates.

But the ECB and Germany, Europe's major power, do not want the central bank to step up purchases if there is any serious risk that the financial support would allow politicians in the troubled countries to backslide on necessary reforms.

Now it's up to the ECB

The hope was that the medium- and long-term reforms agreed to at last week's summit might provide the necessary reassurance to the ECB.

However, it is becoming clear that the central bank viewed the steps as progress, but not nearly enough to justify a major step-up in ECB bond purchases, despite subtle encouragement from many European leaders.

That is a major reason why financial markets have reacted fairly negatively. Unfortunately, this struggle probably will not be resolved without a market crisis leading to a more definitive summit.

The more public struggle is about the role of the UK, which is one of the 27 countries in the European Union, but not one of the 17 that uses the euro as its currency.

There are two levels to that fight.

The long-term, strategic question is how the eurozone will interact with the institutions that run the EU as a whole and with those nations that are in the EU but not the currency zone.

Short -term gain or long-term pain? UK says no - CNN

The British nightmare is a future EU with virtually everyone but the UK in the eurozone, so that the EU institutions are essentially taken over by the eurozone.

The UK would wait outside at European summits while the other countries decided things, which are then formalized after the UK joins for the full EU meetings.

That's not that unthinkable. If the eurozone survives this crisis by becoming much more closely integrated in its decision-making, it will have a great deal of authority in Brussels.

Countries that have joined the EU since the inception of the euro have had to commit to eventually using the common currency, so the UK would be increasingly lonely.

If things go this way, the UK may have to decide to join the eurozone in a decade or two or opt out of the EU altogether.

British Prime Minister David Cameron is fighting a rearguard action to keep the eurozone as separate as possible from the full EU institutions. That's the strategic reason why he refused to help out eurozone members by agreeing to incorporate necessary changes to the zone's rules into a full EU treaty.

Instead, there will have to be a separate treaty agreed to by as many as 26 of the 27 members. (EU treaty changes need unanimity, which is why the UK had a veto.)

Such a separate treaty could face some legal challenges which the leaders would have preferred to avoid.

The tactical reason for the UK veto is that Cameron attempted to use the leverage of his veto power to obtain some changes to proposed financial regulations which many in London believe will harm that city's competitiveness as a financial market.

Finance is roughly a fifth of the UK's economy, so governments take perceived threats to its global position seriously.

If Cameron truly expected to win concessions, as he had signaled fairly strongly, then he failed.

The eurozone leaders turned him down, rather angrily, and went with the proposal for a separate eurozone treaty.

Europe's debt deal is falling flat

It remains to be seen whether this UK vs. Europe fight is the sign of a rupture of the EU, resulting in an eventual British withdrawal, or is just part of the normal jockeying between the core of Europe and the somewhat troublesome islands off its coast.

In the short run, there is a real risk of an erosion in the UK's bargaining position on the financial regulatory issues, since the European anger appears real enough for now.

The final fight sounds very technical. The European leaders proposed to lend money to the International Monetary Fund to enlarge the amount available to deal with a potential worsening of the crisis.

The issue is that the initial proposal is to lend the money directly to the IMF, which would then lend it to whatever country ends up needing it.

This approach leaves the European contributors with the IMF's credit risk, which is very good, but the IMF would have the greater credit risk of the troubled country.

There has been pushback from some other IMF shareholders, who want Europe to put the money in a separate fund administered by the IMF, but with the credit risk remaining with the original lenders.

There are a lot of technical and legal complications, so it is difficult to know which way it will go. However, it appears very likely that something will be worked out.

It could even be the classic compromise of doing it 50/50.