For the past year, I've been warning that the imbalances underlying the financial crisis _ the explosive growth of credit, the mispricing of risk, the mispricing of real estate and other assets, the overcapacity in the global economy _ were so huge that a quick and easy economic recovery was highly unlikely. And for much of that time, it has looked as though I was dead wrong. Stocks rebounded, credit markets revived, corporate profits returned and bank balance sheets have been repaired. But the nagging suspicion is that too much of this rebound is the result of the massive fiscal and monetary stimulus that not only did its job of reversing what was a dangerous downward spiral, but also made it possible for many countries to delay dealing with those fundamental economic imbalances. No better proof exists than the financial drama now unfolding in Western Europe, where for many years countries from Ireland to Greece used the financial cover offered by a new continental currency to overspend, overborrow and overexpand. In the case of Greece, the government took on so much debt during the bubble years that there is almost no way out of its predicament. If Athens manages to make good on its promises to cut spending and turn a nation of tax cheats into taxpayers, there's a good chance it will trigger a vicious deflationary spiral _ falling prices, falling employment and falling government revenue _ that will make it impossible to repay debts. Or Greece could renege on its promises and find itself shut off from further borrowing. Either path leads to some sort of default. The story is somewhat different in other countries, albeit with similar consequences. In Spain and Ireland, the problem is not so much government debt but rather all the private debt used to fuel massive real estate bubbles. Now that those bubbles have burst, the banks that lent that money are facing such huge losses that they have had to be bailed out by the government (in the case of Ireland) or may soon have to be (in the case of Spain). And the ensuing recession has now cut so deeply into tax revenue that even the heretofore fiscally responsible governments of these two countries are now finding it difficult and expensive to borrow new money or refinance existing debt when it comes due. Compounding the problem is that much of this troubled debt, both public and private, is now in the hands of Europe's biggest banks, many of which were already too thinly capitalized and weakened by losses from soured U.S. investments. For European leaders, the decision to finally come through with a $145 billion rescue package for Greece represented a calculated decision that it was less painful, financially and politically, to rescue a profligate neighbor than to rescue their own bankers. Indeed, the problem with European leaders' response to this crisis has been that their exaggerated concerns about appearances have led them to reject useful strategies. It was out of concern for appearances that the European Union initially rejected the idea of allowing the International Monetary Fund to offer an early rescue package for Greece, only to finally relent when the run on Greek bonds turned into a rout. It was out of concern for appearances that the European Central Bank announced sternly several weeks back that it would not allow European banks to borrow by using downgraded Greek bonds as collateral, and that it would never use its balance sheet to monetize Greek debt. This week, however, the ECB began accepting Greece's bonds, now junk, as collateral while hinting that it is open to buying even more on the secondary market. It is now with the same misguided determination that some European officials have tried to shut down any discussion of a restructuring of Greece's debt, or that of any other eurozone country, on the theory that a default for one would be a default for them all. In fact, markets are fully capable of distinguishing between the finances of different countries that may use the same currency, just as they can distinguish the bonds of the state of California from those of Utah. And although any country that defaults will surely face the prospect of being shut out of credit markets for years, that punishment is no different than what was meted out in the past to countries such as Greece and Italy, when they were free to escape financial predicaments by repaying their debts in devalued currency. With the Greek credit crisis quickly turning into a eurozone-wide liquidity crisis, European leaders would be well advised to forget about appearances and come up with an acceptable mechanism for the orderly restructuring of sovereign debt. For just as 'too big to fail' has proven a lousy strategy for banks, it is just as lousy when applied to countries, in both cases encouraging incaution on the part of lenders and profligacy and risk-taking on the part of borrowers. While a debt restructuring would be painful for Greece and its European bankers, it would surely be less painful than a decade of austerity-induced recession. And while a Greek default would probably lead to higher borrowing costs for some eurozone neighbors, that's precisely the sort of post-bubble repricing of risk that is necessary to restore confidence in global markets, rebalance the global economy and provide the foundation necessary for sustainable long-term growth. 