From the start, the eurozone crisis has been a battle over who will ultimately be liable for the billions worth of actual and potential losses on sovereign debt held by European financial institutions. With neither the issuance of collectively backed Eurobonds nor the use of the European Central Bank (ECB) as lender of last resort initially available as options, the European Union, the ECB and the International Monetary Fund decided to protect bank bondholders at all costs, choosing instead to impose losses on taxpayers, even at the risk of stretching governments’ solvency to the breaking point. But because voters’ tolerance for bank bailouts had already worn thin following the initial financial crisis of 2009, governments in the EU core countries began implementing what amounts to a covert bank bailout, lending huge sums to the periphery -- Greece, Ireland and Portugal -- so that they could in turn repay their debts to German, French and U.K. banks in full.
However, the refusal to countenance a Greek default is now dragging the eurozone toward even greater crisis. Already, Greece has proven unable to meet the austerity measures laid out by the EU, the ECB and the IMF as conditions for loans. In fact, imposing austerity on Ireland, Portugal, Greece and now Italy cannot, on its own, solve the eurozone’s problems, which are not merely the result of profligate borrowing by the peripheral nations, but also reflect earlier profligate lending by the core nations. And because the current bailout proposals are operationally unsustainable, they will lead to a broader contagion that will ultimately affect the credit ratings of core countries such as Germany and France.
The best solution economically would be a restructuring of peripheral debt and a recapitalization of the German, French and U.K. banks that predominantly hold it. The primary obstacle standing in the way is the potential political fallout from such an action.