Excerpts from today’s post by Peter Boone and Simon Johnson posted on Baselinescenario.com

In this post, Simon Johnson and Peter Boone appear unfazed by the last minute changes and clarifications in yesterday’s EUR 85 billion Irish bailout package that purport to defer bondholder haircuts for 2013, and discuss alternative endgame scenaria for the Eurozone. Clearly defined endgames cause market participants to work backwards from the future to the present, bringing forward most if not all of the consequences in short order.

The market reaction on Monday, after the bailout was announced, was consistent with precisely this kind of forward thinking by market participants. Quoting from the Bloomberg article linked above:

The twin decisions were not enough to placate investors today that the crisis is now contained. Irish 10-year bonds erased an early advance, European stocks and the euro declined and the cost of insuring the debt of Spain and Portugal against default soared to record highs.

Which brings us back to Simon Johnson and Peter Boone’s main point:

The end point is clear. Last week the markets began to work backwards to today’s debt profiles; major disruptions still lie ahead.

Ultimately, there will be a eurozone will greater shared fiscal authority, a common cross-border resolution authority for failed banks, and likely greater economic integration.

The authors share my view, expressed in Angela’s Haircuts Für Alles, that German politicians have “burned their bridges” and that strategically there is no going back on the commitment to make bondholders share in the burdens. They see four scenaria for how we get to that Eurozone “with greater shared fiscal authority”, and more importantly, who will be in it.

First, as officials hope, the IMF bailouts for Greece and Ireland may work – by stopping the panic and reassuring the investors that there will be enough growth to make even those debt burdens sustainable. This seems most unlikely, particularly given what we have seen of the IMF package for Ireland so far.

In this scenario, everyone can continue to stay inside the eurozone.

Indeed, this scenario seems most unlikely, not least because the market participants are already voting it down with their stampeding feet.

Second, there is the current market consensus that a package of IMF-European Union support for Portugal and perhaps Spain would truly stabilize the situation…

…In this scenario, Greece probably leaves the eurozone and restructures its debt. The Germans say “Greece should never have been admitted; this was the original and only mistake.” Ireland stays in the eurozone but many of its citizens emigrate.

A likely outcome and a path of least resistance for most Eurozone governments, however it is doubtful that this outcome will be stable in itself and that it will not continue to evolve into something worse…which brings us to the third scenario:

Third, there is the thoughtful view of Willem Buiter – currently chief economist at Citigroup and still a brilliant critic of the global financial system. In a presentation circulating last week (not publicly available), he predicts “three or more sovereign defaults in the next five years.” His logic is impeccable – once it is easier to restructure debts, the temptation is to do exactly that; the market knows this and so brings everything forward in time.

Also a likely outcome, because substantial policy paralysis and inaction (which is likely in the EU of 27) is likely to lead to precisely such outcomes. The main question is when, not if.

Fourth, we have the unthinkable – nicely articulated by the Financial Times’ Lex column on Friday. Divide the eurozone into “relatively prudent” and “relatively imprudent”, in terms of fiscal policy…

…Now the eurozone (more likely, some kind of Neue Deutsche Mark, NDM) becomes Germany, the Netherlands, Austria, Finland, and a few smaller countries. Italy is out …

In this scenario, France is the interesting case. Does France leaving the eurozone break the Franco-German alliance that has underpinned European integration since its inception?

Of all of the above scenaria, this is the only stable equilibrium outcome because it amounts to a correction of the basic design flaw afflicting the current Eurozone. Dividing Europe into two economic zones is better than disorderly disintegration. However, as Simon and Peter point out, the question is France. The loss of face involved, and the misgivings about the rupturing of the Franco-German bond that lies at the heart of the European construction, probably mean that politicians will exhaust all other options and allow significant damage to pile up, before this scenario is given a chance. On the other hand, newly assertive Germany can in theory do this without necessarily waiting for an answer from the French, if push comes to shove in the bond markets.

There is more in the article on baselinescenario.com, including more detail for each of the above scenaria. Recommended reading.