A Greek default and Grexit would be disastrous for the eurozone. The remaining eurozone members and the ECB would lose hundreds of billions of euros on their Greek sovereign debt holdings and on Greece’s large Target2 debit in the ECB clearing system.
This huge hit would instantaneously cause a huge market panic in the eurozone as Greece would merely be the first domino to fall. Which domino would it topple next? Spain, Italy or maybe even a northern tier country could go next.
A breakup would be priced into all eurozone markets. Germany, as the largest country with the largest economy, would take the largest financial hit.
If this scenario unfolded, Merkel would not win upcoming German elections this fall. However, German voters are tired of giving the Greeks their money.
The solution to this problem is simple. The troika continues to insist on impossible conditions for Greece as a cover for giving it just enough aid to get by. Greece does not default, but does not improve its condition either.
Merkel does not care. She will try to keep the status quo in place as long as possible, while the Greek resentment continues to build. As long as the Greek government does not fall, she will be able to pull this off.