The euro zone’s reluctance to consider some kind of restructuring for Greece – and at some point Ireland and Portugal – has been heavily criticized by economists, who believe a default of some kind by one or all three of the troubled economies is now inevitable.
The debate centers on a single question. Who do you bail out? The troubled nations? Or the institutions that hold the debt they are being weighed down by?
“These bailouts are actually bailing out the banking sector of creditor nations, such as Germany and France, and not the economies that are in trouble, like Ireland and Greece,” said Devina Mehra, the chief strategist at First Global in a research note on Friday.
“By kicking the can down the road (read buying time), which is the sole objective of the bail-outs, they are allowing their national banks to settle their accounts with these troubled economies,” said Mehra.
Since the euro zone debt crisis, the major banks of Germany and France have been reducing their exposure to the debt markets of the euro periphery.
“Net exposure of European banks into PIGS (the last row) has fallen from over $500 billion to around $230 billion at the end of 2010, marking a decline of almost 55 percent in a year,” said Mehra, referring to the economies of Portugal, Ireland, Greece and Spain.
“The numbers suggest that German and French banks, which were at the heart of any mishap in all these troubled economies, have successfully capitalized on the situation to reduce their exposure to the troubled nations,” he said.
This, in Mehra’s view, will make matters worse for the troubled nations as selling pressure adds to the borrowing costs of the troubled nations.
“Who cares about the homes of the neighbors when one’s own house is on fire?,” he said.
“If debtor nations are forced to pay for their mistakes by bringing their fiscal house in order, which has hit their economies so hard that all the benefits enjoyed in the last decade have been reversed, lenders cannot be allowed to have a free lunch," said Mehra.
“The troubled nations are being hurt further in the process, as they are being forced to implement more austerity measures in order to bring their fiscal house in order, the creditors are only getting rid of the toxic assets (that becomes even more toxic due to this process) on their balance sheets,” he said.
With all three nations likely to resort to some kind of restructuring at some point the big loser is likely to be the ECB’s balance sheet, according to Mehra.
“Should Greece default and the ECB decide to cut its life injecting capital supply to these banks, then the ECB’s balance sheet will be equally hit and hence, it will think twice before making such a move,” he said.