Europe Split Over Debt Crisis Hardens

The dispute between Europe's central bankers and politicians over how to deal with Greece's worsening financial problems intensified, as one of the European Central Bank's top officials rejected calls by Germany and other euro-zone states for a restructuring of Greek debt─calling it a 'horror scenario.'

The comments from Bank of France Governor Christian Noyer, a member of the ECB's governing council, mark the latest salvo in an increasingly heated debate that is fueling fears among investors that the region's debt crisis has entered a dangerous new phase.

The standoff─which has pitted Europe's central bank against Germany and several other euro-zone governments─cuts to the heart of a question at the center of the region's 18-month crisis: how much are the euro area's wealthier members willing to pay to keep the bloc intact.

At issue is whether Greece, barely a year after receiving a 110 billion ($155 billion) bailout, should be forced to default on its obligations or if Europe should extend it more aid. The ECB worries about the consequences even a mild debt restructuring could have on Ireland and other weak euro-zone countries, while leaders in the currency bloc's strong economies, foremost Germany, fear the political cost of further bailouts.

Moody's Investors Service on Tuesday also warned about the consequences of restructuring, saying any Greek debt default would likely torpedo the country's credit for a 'sustained' period, possibly thrusting Greek banks into default and leaving other weak euro countries 'struggling' to stay out of junk territory.

The head of France's Société Générale, one of Greece's creditors, echoed the restructuring concerns, saying it would be difficult to convince investors that Greece was a one-off. There are consequences for 'how the market will look at the European Union and each country,' Société Générale Chief Executive Frédéric Oudéa said in an interview. 'In my view, the issue is not really just the Greek issue.'

The outcome in Greece could hit Ireland, which was forced to seek a bailout last year. Ireland's government is less indebted that Greece's, but its banking system is fragile and fears of debt restructuring could reignite the crisis there.

The disagreement within Europe's leadership revolves around a basic question: What to do as Greece, again, runs out of money? There is broad agreement in Europe that the 110 billion granted last spring isn't enough to get Greece through next year. But there is practically no agreement on how to plug the gap.

Under intense political pressure, leaders in Europe's stronger economies are deeply reluctant to simply write another check. That, many fear, would put the euro zone too far down the road to a fiscal union, in which strong countries have no alternative but to pay for weak countries. Instead, Berlin and its allies want Greece and other weak countries to repair their finances through deep spending cuts and debt restructuring.

The ECB's position is that Greece's financing shortfall must be filled by other euro-zone countries once Athens has exhausted all options for paring its budget and selling its state assets─not by delaying or reducing payments to creditors.

But several key European finance ministers, including Wolfgang Schäuble of Germany and Christine Lagarde of France, have left the door open to a so-called reprofiling of Greece's debt. Under that scenario, Greece's private creditors would be asked to accept repayment later than expected, to help Greece cover its fiscal holes in 2012 and 2013.

Such a rescheduling would lessen─or, in an optimistic scenario─obviate the need for European governments to pay for a second bailout. At the least, a reprofiling would mean that private-sector creditors feel some pain, along with taxpayers.

Since the debt crisis emerged in early 2010, nearly all of official Europe had maintained a euro-zone debt default of any flavor was unthinkable. National leaders feared a loss of prestige and a hit to confidence in the region. ECB officials feared the Continent's fragile banks, unprepared for losses on what they had thought were ultra-safe investments, could collapse.

But as national leaders have faced the consequence of that position─that preventing a euro-zone debt default means they must always be ready to write more bailout checks─they have backed off.