The Credit Crunch Crosses the Atlantic

For months, as global financial woes spread, U.S. banks stood front and center amidst the chaos. October 6 provided something of a counterpoint. Following Germany's announcement that it would temporarily insure all holdings in German bank accounts to protect against a run, European markets led a sharp global stock plunge that carried over into the United States. Leading indices in France and Germany dropped over 6 percent, and Britain's FTSE 100 index fell nearly 8 percent; the Dow Jones Industrial Average subsequently plunged in early trading, falling below the 10,000 mark for the first time in four years. Concerns about the implementation of the U.S. bailout plan factored into the day's declines, but analysts say the losses also reflect an emerging recognition that financial problems in Europe are significantly deeper than had previously been thought.

That recognition comes alongside a drumbeat of bad news. Germany's massive new bank precautions-which will insure holdings worth $771 billion-come on the heels of a separate bailout in which Berlin provided a $68 billion rescue package to the German national mortgage lender. Nor is Germany the only country foundering. Last week, Britain nationalized its biggest mortgage lender, Bradford & Bingley, following the firm's rapid collapse. The governments of Belgium, the Netherlands, and Luxembourg made emergency plans to divide the Belgian-Dutch bank Fortis into three parts and co-nationalize it-though that plan fell through and the bank was forced to sell large parts of itself to the French bank BNP Paribas. Iceland, whose banks had pressed to expand rapidly abroad, now finds itself in particularly dire straits-Forbes reports the country's national coffers might not be deep enough to bail out its banking sector.

Iceland's prime minister is taking a cautious approach, encouraging banks to look abroad for emergency capital, but the Economist says many other European banks are taking on obligations they could find hard to keep. Ireland, for instance, recently said it would guarantee the liabilities of all its banks-a promise that brought capital rushing into Ireland from across Europe. Germany quickly followed up with a similar promise, and on a much larger scale. Denmark followed suit, and Britain, which has a much larger banking system, moved to raise the limits on deposit insurance, much as the United States has.

The problems for Europe's banks don't end there. In a new interview with, Nouriel Roubini, a New York University economics professor and founder of RGE Monitor, notes a plethora of problems making Europe's banks "very vulnerable." He cites bursting housing bubbles in Britain, Ireland, Spain, Italy, France, and Portugal; a liquidity crunch spilling over into Europe from the United States; and European banks' heavy investment in tenuous markets. European banks have significant exposure to Eastern Europe, and Scandinavian banks to Iceland and the Baltic states, all of which had significant market run-ups and, Roubini says, "are on their way to a hard landing."

The best policy answer, many analysts say, is major coordinated action by the European Union. The Associated Press says a majority of analysts now back rate cuts by the European Central Bank, which had pursued a policy of holding rates steady before raising its benchmark rate to 4.25 percent in July. Roubini goes further, saying Europe, the United States, and other leading world economies should coordinate major rate reductions to show they are serious about combating the crisis and the broader economic problems it could spawn. Other analysts have suggested a common European bailout fund, saying it would be more effective than the piecemeal lending programs several countries are pursuing. But this idea was rejected at October 4 meetings between the leaders of France, Britain, Germany, and Italy, in large part due to German opposition. Given the events of this week, however, the Economist says Europe's leaders would be well-advised to reconsider that decision.