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Does Merkel Need a 'Lehman Crisis' to Save Euro?

In 2010 former US Treasury Secretary Hank Paulson admitted that if had not allowed Lehman Brothers to fail, he would have not been able to win approval for the Troubled Asset Relief Plan (TARP) -- the bailout of the country's banks -- from Congress.

German Chancellor Angela Merkel
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“We didn't have TARP without Lehman Brothers," Paulson said. 

The idea that Paulson needed a crisis in order to solve a bigger crisis could be seen by some as a post-game rationalization by the former official, but it raises some interesting questions for German Chancellor Angela Merkel and Europe's ongoing sovereign debt crisis.

The Chancellor finds her government in a very difficult position. Under pressure from her own voters not to throw more domestic tax money at efforts to buttress the finances of foreign countries like Greece, Italy and Ireland, Merkel is being heavily criticized by those who believe she needs to sign off on a Eurobond in order to draw a line under the debt crisis once and for all.

Merkel said over the weekend that a Eurobond is the wrong answer for the current crisis and told political rivals in Germany yesterday that their demands for an EU-wide bond market are "grossly negligent."

The rhetoric from Merkel needs to be taken with a grain of salt. Her hardline stance on the Eurobond is confusing for global markets and her political peers across Europe. Merkel’s numerous assertions that the Eurobond is off the table, if taken at face value, would convince most people that the idea is a non-starter.

On Monday morning, many headlines made Merkel's message very clearly, but not everyone is convinced. Deutsche Welle, the German daily, read her comments less than literally, leading their coverage with "Merkel, Still Hesitant, Shows Wriggle Room around Eurobonds.”  While Merkel can't sign off on a Eurobond now, the paper said, she has not completely ruled out the idea at a later date.

There has been a tectonic shift in Merkel's hardline stance in recent days, as CNBC has reported. By saying "not now," Merkel has indicated only that she cannot agree to a Eurobond at this time. It doesn't rule one out in future, if and when the necessary legislative and political framework is in place.

Building that framework will take time. Merkel simply can't make anything happen quickly, given domestic pressure from her voters to avoid underwrit ing  the entire euro zone. A recent poll for ARD, the German public broadcaster, found that 78 percent of people where either not very confident or not at all confident in Merkel's leadership during the euro crisis.

At this time, Merkel simply does not have the political capital  to win support for a Eurobond, and her meeting with French President Nicolas Sarkozy last week made that much very clear. Talking of true economic governance and a step-by-step process -- starting with deficits being brought under control --  could very well be an attempt to buy time.

The recent market volatility and fears over the euro zone banking system show that the market may not give Merkel and her peers much more time, which evokes the parallel with Hank Paulson's dilemma in 2008.

If faced with a major crisis such as the failure of a big European bank -- which is by no means assured but certainly not impossible -- Merkel may be forced to act in order to hold the euro zone together.

Like Paulson in the autumn of 2008, selling a shock-and-awe response domestically could be a lot easier in the face of a major crisis.

The impact of some major crisis on the market and global economy are impossible to predict, if in fact such an outcome transpires. But if the market wants a Eurobond, it might need to get used to the idea that only a near-disaster will give Merkel the cover she needs to deliver one.