The Consequences of Angela Merkel

LONDON – Germany has been leading the opposition in the European Union to any write-down of troubled eurozone members’ sovereign debt. Instead, it has agreed to establish bailout mechanisms such as the European Financial Stability Facility and the European Financial Stabilization Mechanism, which can lend up to €500 billion ($680 billion) combined, with the International Monetary Fund providing an additional €250 billion.

These are essentially refinancing mechanisms. Heavily indebted eurozone members can apply to borrow from them at less than the commercial rate, conditional on their committing to ever more drastic fiscal austerity. Principal and interest on outstanding debt have been left intact. Thus, creditors – mainly German and French banks – are not expected to suffer losses on their existing loans, while borrowers gain more time to “put their houses in order.” That, at least, is the theory.

So far, three countries – Greece, Ireland, and Portugal – have availed themselves of this facility. In mid-July 2011, Greece’s sovereign debt stood at €350 billion (160% of GDP). The Greek government currently must pay 25% for its ten-year bonds, which are trading at a 50% discount in the secondary market.