The only responsible course of action for Merkel and EU is to heavily cut Greece's debt. Even if it wasn't for the fact that German and EU banks are partially responsible for the crisis with their irresponsible lending, it is as you said,  Greece cannot pay. They can either continue their draconian austerity measures and repayment demands which will cause further destabilization and harm Greece's economy even more, or accept the very real fact that Greece simply cannot pay, cut their losses and move on.