Germany's Gift to Euro Integration

by Simon Nixon

Wall Street Journal
June 28, 2011

Angela Merkel has been dealt a lesson in the markets.

Last week, the German chancellor conceded the euro zone doesn't have the tools to deal with the side effects of imposing losses on Greek government bondholders. It's a shame she didn't work this out 10 weeks ago before her government's efforts to restructure Greek debt succeeded in destabilizing the euro zone and global economy. A far more comprehensive plan is now needed to tackle the euro crisis, regardless of whether Greece defaults or not.

What Ms. Merkel and other policy makers and investors advocating an early Greek default failed to realize was that far more is at stake in this crisis than the bondholders of a small euro-zone economy: At its heart, this remains a banking crisis as much as a sovereign-debt crisis. A simple calculation of the losses from any given level of reduction applied to Greek debt, called a haircut, even if one includes possible losses under credit-default-swap contracts, could never give an accurate picture of the mayhem a default might unleash. That is because the principal contagion risk always was via the bank-funding market.

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