No, this is not going to work
This plan succeed in preventing a financial market meltdown on Monday, and that's good. But that's the best thing I could say about it.
But since we are already living in the long-run from the perspective of Sunday, it is worth looking at some of the plan's economic consequences.
At first, I was somwhat struck because the scheme did not mention specific money market guarantees. Of course, this is not necessary if you are saving the entire banking system. In that case, any money market guarantee is implicit as long as everybody else does the same. In that case, no cross border issues could logically arise. Otherwise, it would have been completely mad to issue national guarantees for a cross-border euro area banking market.
Unfortunately, it is still mad, because the premise is wrong that we can save all the banks. The European Commission says there are 44 systemically important banks in Europe that we must save, should they fail. That estimate is about right. Of those 44, there are 2003 systemically relevant banks in Germany alone, because we do not agree on the definition of systemically relevant. The German government happens to define any bank as systemically relevant. Since the German banking system is de facto insolvent (not every bank, but...), this is going to be prohibilively expensive. The €500bn number is just for the press. So far only €100bn is real money, some 4% of GDP, the rest is a de facto open ended political promise. It will cost as much as it takes. The German banking system's total assets are almost €8000 billion, so if and when credit markets deteriorate further, and if recession strikes, there is no guarantee that €500bn this will be enough to avoid insolvency.
So we have two options. We continue to try to save every single bank, systemically relevant or not, in which case we will have successfully transfered a private sector credit risk into a public sector solvency risk. We will have done what Iceland did, on a bigger scale.
Or else, we would only guarantee the systemically important banks, which is effectively all we can afford, considering that we might also want to spend a bob or two on a fiscal stimulus to ameliorate this very sharp recession. But in this case, not every bank is safe, and consequently cross border issues can arise. In that case we would need some explicit money market insurance, with a cap perhaps.
So this leaves us with the inescapable logic of a pan-European bank rescue plan. If we had done this from the start, it would have been a lot cheaper, since it is cheaper to save 44 banks than all 8000, the total number of banks in the EU. The rules would be a lot more symmetric.
My guess is that such a plan will come at some point, but it will come in addition to the national plans, so that the public finance implications will be even worse. The most probable way out of this dilemma is higher inflation. (The alternatives are punitive taxes or spending cuts). The US will almost certainly solve this problem through inflation. Whether this will happen in Europe is not certain. The ECB is certainly not going to be a willing accomplice, but frankly, if faced with the prospect of national insolvency, and an increase of inflation into the high single digits, even the Germans and the Dutch might probably choose the latter. The choice might not be as stark, in which case some intermittent options are possible. But these plans raise very serious long-term issues for public finance and monetary stability, unless the credit crisis ends soon. And that, I am confident to predict, is not going to happen.