The European policymakers who will meet in Brussels for a special summit today are all agreed that Greece urgently needs another bailout. Yet what they cannot agree on is over whether those banks that hold Greek sovereign bonds should be forced to contribute to the costs of such a rescue package through a reduction in the face value of their debt holdings.
The German Chancellor, Angela Merkel, insists that they must. But other European policymakers, including the head of the European Central Bank (ECB), Jean-Claude Trichet, argue that this would be unacceptable. Mr Trichet has indicated that the ECB would stop accepting Greek sovereign debt in exchange for cash if its face value was reduced, effectively threatening to bankrupt Greek banks if the Merkel proposal goes ahead.
Ms Merkel has been behind the curve throughout most of this crisis. But she is right to insist that the bondholders need to shoulder some of the costs of a new bailout. There are two reasons. First, Greece does not only need its debts to be rolled over – it needs some of those debts to be written off. Otherwise it has almost no chance of economic recovery. The bond markets themselves accept this reality. This is why Greek debt has been marked at a significant discount for many months now. It is Mr Trichet who is in denial when it comes to the possibility of a partial Greek default. Second, it is a democratic imperative that those European banks that lent so freely to Greece over the past decade, paying their employees vast bonuses in the process, should contribute to the costs of the clean-up now.
What Mr Trichet and others imply through their opposition to any kind of bondholder pain is that European taxpayers should be prepared to bail out the private banks that lent to Athens forever if necessary. It is not only in Germany where opposition to this extreme prescription is growing. The Irish prime minister, Enda Kenny, was elected earlier this year on a promise to get the holders of Irish sovereign debt to accept a reduction in the value of their bonds. Like many in Greece, the Irish government is not prepared to accept the prescription of endless austerity in order to ensure that profligate bank lenders across Europe receive all their money back.
Mr Trichet's concerns about the possibility of another disastrous financial panic if lenders to European governments are forced to take losses are reasonable. But those concerns are not a good enough reason to obstruct the Merkel proposal. The appropriate response from European policymakers to the danger of financial contagion is preparation, not paralysis. They should be preparing to contain the effects through a recapitalisation programme for the continent's banks and the creation of common European bonds (backed by all members of the eurozone) with the proceeds going to those nations that have been shut out of the debt markets.
Yet such radical – and necessary – action looks depressingly unlikely. Despite the fact that interest rates on Spanish and Italian debt have been creeping ominously upwards, Ms Merkel has already played down the chances of agreement being reached at today's summit. And so Europe's leaders continue to fiddle as the single currency staggers ever closer to the precipice.