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By Jonathan Chen

Okay, so the equity markets on spiking on news from over the weekend that Dexia SA was going to be "saved," and that German Chancellor Angela Merkel and French President Nicolas Sarkozy have agreed upon a "plan" to save Europe.

Well that's all good and well, except there is no real plan, and the Belgian government, which is heavily involved in helping bail out Dexia (OTCPK:DXBGY), is so far in debt that it does not make sense.

Belgium has a debt-to-GDP ratio of 99%, higher than the U.S. For such a small country, it has $480 billion in debt. By guaranteeing 60.5% percent of the $121 billion that Dexia currently has in liabilities, this makes no sense at all. It also makes no sense that the Belgian unit of Dexia SA was able to be sold to the Belgian government for 4 billion euros ($5.4 billion) in order to prevent the Belgian-French financial institution from going bankrupt.

There was also the small, "tiny" matter of Moody's Investors Service placing Belgium's credit rating on review last week for possible downgrade, mostly because of the rescuing of Dexia. Well, that happened. You can guess what is next.

There is also the little matter of the supposed plan that Europe has to help the banking sector, and recapitalize it, preventing Europe from a financial Armageddon. So far, we have heard no concrete details, just that we would have a plan by the next meeting. The meeting has now been pushed back until October 23.

The European Union still needs the European Financial Stability Facility expansion to pass, and Slovakia's SAS Party is not in favor of an expanded EFSF. This morning, the party said will not change its stance on the EFSF. Slovakia is due to vote tomorrow. So essentially, what we learned over the weekend is that Merkel and Sarkozy are trying to get Slovakia to agree to an expanded EFSF, otherwise their plan goes up in flames. Only, it does not appear they have anything to offer Slovakia, just yet, and they have no real details on how to recapitalize the European banks.

In other words, they plan to have a plan.

With Slovakia potentially not passing the EFSF expansion, and Merkel continuously opposed to Eurobonds, it seems like the market is long on hope, and short on details. Not the best pairs trade if you are an investor.

Merkel said over the weekend, “[W]e are determined to do whatever is necessary for the recapitalization of our banks”, and that Germany and France "are working closely together on Greece.” At a press conference, Merkel denied giving any details on the plan. “The French president [Sarkozy] said we are not going into any details today,” she added. “The whole package will be ready by the end of the month.”

You know why she declined to give details? Because they do not have any. Wolfgang Schäuble, Germany's finance minister is so far from Merkel's stance on saving Greece, and is against having private bond holders take massive haircuts on Greek debt. A haircut of around 21% has already been agreed to, but some have said that we need something as high as 60%, perhaps more. Schäuble has continuously said that is not going to happen, and Merkel's stance in Germany has been weakened because of this.

There is still time for the German and French governments to come to a common ground (mind you, they are still far apart on how to save Europe), and for Merkel to get Schäuble on her side. We will continue to see the volatility we have seen over the recent months continue until Europe is solved.

Or in this case, until it is not. Then we will just hear another plan to have a plan, and we will rally another 300 points on the Dow. But that very well may be from a much lower level.

ACTION ITEMS:

Bullish:
Traders who believe that Europe will finally get its act together might want to consider the following trades:

  • Consider going long the Euro ETF, CurrencyShares Euro Trust (NYSEARCA:FXE), as the euro could rally back to the $1.40 level.
  • Also consider going long European banks, such as Deutsche Bank (NYSE:DB) and BNP Paribas (OTCQX:BNPQY), which may rally on recapitalization plans.

Bearish:
Traders who believe that this is just another detail-less plan may consider alternate positions:

We could drop sharply as euphoria wears off when the bond market reopens tomorrow, and traders realize the plan is empty. Consider shorting the S&P 500 ETF (NYSEARCA:SPY) if you believe Merkel and Sarkozy do not have a real plan.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Why Europe's Plan Is Dead Before Arrival