Mrs. Merkel makes a good move

The widely leaked existence of a Plan B whereby Germany would support its banks and insurance companies should Greece default on its debt is a constructive move forward:

1. It attempts to delink Greece from the European and world financial markets.  As Mrs. Lagarde noted last month, banks are unfortunately very efficient instruments of contagion, so that strengthening them is the best way to contain the Greek crisis;

2. It sends a very clear message to Greece that Germany is not obliged to bail it out, particularly if it doesn’t fulfill its commitments.  By announcing Plan B, Mrs. Merkel defuses any possible blackmail from Athens;

3. Finally, it forces France, Italy and others to provide similar protection to their own banks, which in turns should stabilize the financial markets and set the stage for a realistic Greek debt workout.

Bond and stock markets have lost a multiple of Greece’s public debt in value.  It shouldn’t be, and this move by Mrs. Merkel is welcome.

Longer term, it is getting ever clearer that the Greek debt will be restructured along realistic lines.  While I originally thought that a wider privatization program could keep the total “haircut” at or below 20%, I no longer feel that confident.  Even if Greece embraced a €100 billion program, I don’t see how the haircut could be less that 40%.

Finally, the Merkel move is also a warning to Portugal and Ireland, although their prospects are not as dim.  As for Spain and Italy, there is no European plan yet.  Spain seems to be taking measures to reduce its deficit, but Italy is further behind, appears less committed and represents a much bigger challenge.  No doubt Mrs. Merkel will need to keep working hard.