October 7, 2011

Merkel, Sarkozy Battle Over Greek Default

French banks debt holdings could threaten country's Triple-A rating

There is a great divide yawning between Germany and the rest of the eurozone over the question of whether Greece should be allowed to default. While Germany says it will do all it can to avoid such an event, France is desperate to avoid it at all costs.

A default would mean potential disaster for French banks as well as a possible loss of the country's Triple-A credit rating. And if that goes, the financial rescue mechanism for all the eurozone could fall apart; France is the second biggest guarantor of the fund after Germany.

Bloomberg reported Friday that Angela Merkel, German chancellor, is pushing to prepare investors for an inevitable Greek default. Opposed to using the European Financial Stability Facility to recapitalize banks, something French President Nicolas Sarkozy is advocating, Merkel instead wants to wall off Greece from the rest of the eurozone without it departing the currency bloc entirely.

She was quoted saying, “We have to be able to put up a barrier. I don’t rule out at all that at some point we will have the question of whether one can do an insolvency of states just like with banks.”

However, Sarkozy is determined to “save” Greece, knowing that a default would threaten French banks with large exposures to Greek debt. A threat to the banks means a threat to France's Triple-A credit rating, and that could in turn threaten the entire eurozone rescue mechanism. He is advocating using the stability facility to recapitalize banks, French banks in particular, to keep them humming along and prevent Greece from defaulting.

Referring to the eurozone as a family that must protect its weakest members, Sarkozy was quoted saying, “The failure of Greece would be the failure of all of Europe. Remember in 2008, when the U.S. let Lehman Brothers fail, the global financial system paid the price. For both economic reasons and moral reasons, we can’t let Greece fail.”

The two leaders are to meet Sunday to hash out differences, but the gulf between them is wide and deep. Paul De Grauwe, an economics professor at the Catholic University of Leuven in Belgium, said in the report, “Franco-German cooperation hasn’t worked well in terms of solving the crisis. The two have pursued different objectives.”

Stefan Collignon, a former German Finance Ministry official and political economist at the Sant’Anna School of Advanced Studies in Pisa, Italy, was quoted saying, “The whole German debate about a default of Greece is a German debate, not a European debate. The commitment everywhere else, including in France, is very much to avoid that by all possible means.”

Reuters reported a German source saying, "The French have misunderstood the EFSF. Our position is that banks should seek money in the markets first, then come national backstops, and only when there is no money available would it kick in at the European level."

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