European politicians should let Greece, Ireland and Portugal default while taking steps to ensure Italy and Spain won’t, according to Pacific Investment Management Co.’s Neel Kashkari.

“They are delaying and denying as long as possible because the medicine to actually put out this crisis tastes so bad,” Kashkari, head of new investment initiatives at Pimco, said in an interview on “InBusiness With Margaret Brennan” on Bloomberg Television. “They are always behind, always trying to play catch-up, and the crisis is always getting worse.”

Germany, France, the International Monetary Fund and the ECB should unveil a “massive” bailout package and announce it’s available to the entire eurozone, except for Greece, Ireland and Portugal, effectively letting them default, according to Kashkari.

That would create a firewall protecting Italy and Spain, said Kashkari, who joined Pimco in December 2009 after serving as head of the U.S. Treasury Department’s bank-rescue program. Pimco, based in Newport Beach, California, operates the world’s biggest bond fund.

“One, two or three countries may have to take a sabbatical; this is where we are going,” Mohamed El-Erian, chief executive officer of Pimco, said in a Bloomberg Television interview on “Surveillance Midday” with Tom Keene. “You cannot converge financial variables without converging economic variables. The most important compromise is to stabilize the core.”

German Chancellor Angela Merkel and French President Nicolas Sarkozy Wednesday ruled out steps such as the issuance of euro bonds or expanding the bailout fund in their latest strategy to counter the euro debt crisis.

Sarkozy and Merkel spoke after a two-hour meeting in Paris as investors called for signs that they would do more to end the debt storm after reports showed an unexpected slowdown in their economies. Unprecedented bailouts by governments and the European Central Bank have failed to stamp out concerns that began in Greece almost two years ago and rattled markets in “AAA” rated France last week.

Greece “has too much debt and is not competitive enough,” said El-Erian of Pimco, which runs the world’s biggest bond fund. “It’s difficult to see Greece overcome these issues within the eurozone.”

According to Kashkari, a system in which “AAA” rated countries such as Germany ultimately guarantee the debt of higher-risk governments is a solution that is “elegant conceptually, hard politically.”

Merkel and Sarkozy also rejected an expansion of the 440 billion-euro ($633 billion) rescue fund yesterday, a decision Kashkari said was the wrong one.

“If we tripled the fund, then at the next press conference you would ask us why didn’t you multiply it by four,” Sarkozy said. “We’re trying to manage it seriously and reasonably. We believe the fund is sufficient.”

The announcement from the German and French leaders came after a report showed the euro-area economy grew 0.2 percent in the second quarter, the worst performance since emerging from recession in 2009.

“How do you get the German taxpayers to write these checks?” Kashkari said. “It may be easier politically to have the Germans bail out the ECB than the Greeks and the Irish, but that may ultimately be what happens, and the economic effects may be similar.”

The ECB’s shouldering of the burden of the region’s debt and being bailed out by Germany is a more likely scenario than the issuance of euro bonds, Kashkari said.

“Some people will say it will never happen,” El-Erian said in reference to a smaller eurozone. “I suspect it will be bilateral. We will have an ad hoc way to do it because that’s going to be what’s in the interest of the eurozone, but ultimately also in the interest of a country like Greece.” 

(Bloomberg)