06/10/2011 10:45 am ET Updated Aug 10, 2011

Greece: Angela Merkel Is Right, but Will It Help?

After the last meetings in Greece and in Brussels, there is no illusion left. Greece is not even close to the implementation of its reforms. Contrary to Spain and Ireland, there is no consensus between the ruling party and the opposition. Prime Minister Papandreou no longer has the confidence of his people, neither does he have the confidence of his European partners.

In those conditions, the absence of consensus in Greece and among the partners of the Eurozone, the situation is deteriorating rapidly, with 2-year bonds by the Hellenic Republic trading at an interest rate level above 25%.

The position of Angela Merkel is clear: there is no justification for a new bailout package that would go above the current $150 billion level without participation of the private sector. The German Parliament endorsed that position today. The argument is politically simple "Why would German workers work until they are 65 to assist Greek workers who stop working at 55?" It is brutally simple. It is eminently right.

Assuming Europe is not going to inject more money to support the Greek chaos, what is the alternative? A restructuring of the Greek debt without a loss by the bondholders of part of their investment would have no effect. Further intervention by the European Central Bank is unthinkable. The ECB owns roughly $50 billion and the non-Greek European banks $150 billion. Together, they represent more than half the Greek debt.

Why not accept the reality? Greece is virtually bankrupt, its debt is worth less than 50 cents to the dollar and the Greek banks are also bankrupt. The only solution must come from the lenders who have a vested interest in restructuring their portfolio. The European Central Bank, who did, under political pressure of its Member States, accept to purchase Greek debt, is a central bank. If it loses $10 billion in the adventure, its credibility as the pillar of the Eurozone is threatened.

Behind that, the rear guard battle of the European Banks who are exposed to the risk of such restructuring and have a weak level of equity to absorb the losses, is pushing the solution forward ... towards the precipice. The stress tests of the European banks have been postponed and will not be meaningful anyway. Nobody wants the truth to be exposed.

Angela Merkel's dilemma is therefore cornelian: if she refuses to lend more money there is a serious credibility problem that could lead to a European financial crisis that could become contagious to Spain, Italy and even France or Belgium.

The biggest mistake of the European leadership has been to refuse the medicine that they imposed to other countries around the world: no money without concrete reforms. Greece should have sold its public enterprises long time ago, and certainly over than last two years. Any indebted country, corporation or family has to sell assets when they have become over indebted. Why did the IMF, who took one third of the burden of the bailout, accept to renounce to its strict principles? Is it because Dominique Strauss Kahn is European? In this context, a European Director General of the IMF would run a nest of conflicts of interest. Madame Lagarde yesterday took an unacceptable position, defending French banks who are the largest lenders to Greece.

It is difficult to know what Angela Merkel will eventually decide. Between two impossible solutions, the best one is the one that is right. Stop lending more money to Greece and let the market mechanisms play their role. Every other solution will make the situation worse.