AFTER THE BAILOUTS, CRACKS ARE SHOWING / THE WALL STREET JOURNAL ( VERY HIGHLY RECOMMENDED READING )

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APRIL 18, 2011, 4:43 P.M. ET.

After the Bailouts, Cracks Are Showing .

By RICHARD BARLEY

Reality bites. The financial crisis was contained for a while as governments backed the financial system with their bigger, more resilient balance sheets.

But the strains are beginning to tell.


To add to the fractious political debate over the deficit, the U.S. now has a negative ratings outlook to concentrate minds. In Europe, an anti-bailout party in Finland has won huge popular support, and debt markets are skittish again. The policy response to the crisis, which sought to kick hard decisions into the future by reflating markets, is running out of road.


The European situation is more immediately threatening. Sparked both by persistent talk of a Greek restructuring and a big vote in the Finnish elections for the True Finns party, which opposes further bailouts, the risk of contagion looms once again. Spanish ten-year bond yields, at 5.56%, are back at their highs for the year.


No euro-zone debt restructuring is needed immediately.


The weakest country, Greece, is funded until early 2012. From policy makers' perspective, a hit to bondholders right now could trigger a deeper recession in Greece and a fresh hit for European banks, which as of late 2010 still had $154 billion of exposure to Greek entities, according to Deutsche Bank.


But taxpayers are effectively taking the place of financial institutions as maturing debt from bailed-out nations is being paid off at par. Without euro-zone support, Greece would already have defaulted.


The Finnish political situation poses heightened near-term risk, given that Portugal faces a €5 billion ($7.2 billion) bond redemption in June, and euro-zone bailout packages must be agreed to unanimously. But either way, the tone of the political debate in Europe is changing, with people less willing to write blank checks to push off problems.


From this angle, it is healthy that there is growing debate among creditors about a Greek debt restructuring, in contrast to previous blanket denials.


Admitting the depth of the illness might reduce the eventual shock. A similar shift may be starting in the U.S.


Monday's shot across the bow from Standard and Poor's does little more than state the obvious, that Uncle Sam's fiscal course is unsustainable.


But it is a reminder deficits have to be tackled at some point. The more-exposed U.K. has started on this journey. S&P is looking for a meaningful start to U.S. fiscal repair by 2013.


The financial crisis moved unsustainable debt from overburdened consumers and banks to governments, who sought to defer the problem. That made sense when the financial system was ready to collapse.


But that is no longer the case. Many central banks are already preparing to rein in their huge monetary responses. Investors need to prepare for governments doing the same.
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