No Exit: Europe in Panic as Sovereign-Debt Fever Spreads

4 Agosto 2011, di Redazione Wall Street Italia

Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

You know it’s bad when the man standing between you and the precipice is — wait for it — Silvio Berlusconi! With financial panic spreading in Europe, the noted Italian playboy and prime minister sought to assure global investors today that tutto bene in the world’s seventh-largest economy. Astonishingly, they didn’t believe him:

“Berlusconi is more interested in his bunga-bunga parties than his bond market,” said Louise Cooper, a markets analyst at BGC Partners in London.

Hey, who doesn’t like a little bunga-bunga now and then? Yet Berlusconi’s credibility gap illustrates the eurozone’s broader problem — no one believes that the band-aid EU officials recently applied to Greece’s oozing sovereign-debt crisis will work.

Fear factor

Signs of panic in Europe are everywhere. Italian, Spanish and Portuguese bond yields are spiking, as investors demand higher returns to offset perceived risks. Spain postponed a debt auction, raising concerns about its ability to raise capital. European stocks plunged, with the sell-off spilling into the U.S.

Germany, France and the region’s other stronger economies, which are anchoring the Greek bailout, are also experiencing slower economic growth. That affects their ability to rescue even smaller countries, let alone larger states. In short, Europe’s debt woes are conjoining with growth problems.

Concerns are also growing about the stability of Europe’s financial system, especially Italian and Spanish banks. Reports the NYT:

The growing vulnerability of the giant banks in these two countries is spurring investor fears that Europe?s latest bid to get a handle on its festering debt crisis, adopted just a few weeks ago, has come up short.

The banks own so many bonds issued by their home countries that they are being weakened as the value of those bonds falls, amid concerns that the cost of government borrowing could become too expensive for Italy and Spain to bear.

Why time is running out

If it sounds glibly premature to write the eurozone’s obituary, that’s only because the speed of the collapse is hard to fathom, just as it was in the U.S. in September 2008. Put another way, European officials are running from an avalanche. They’re moving too slowly to stay ahead of the crisis, while the wall they built in Greece last month is too weak to withstand the force threatening to engulf the continent.

And crucially in such crises, investor psychology has darkened, with financial markets increasingly pessimistic that the slide can be stopped. As the Economist notes, for instance, Spain’s public debt is lower than average in the eurozone, while Italy’s budget is in surplus. Yet bond prices in both countries are tumbling. That’s fear working.

By now, the obstacle to a solution in Europe no longer appears chiefly political, as it was in convincing German taxpayers to backstop Greece. Rather, the central question now is whether European and IMF officials can avert economic disaster even if they wanted to. Although they have expanded the eurozone’s bailout fund, it is far too small to save Italy if the country’s debt problems continue to grow.

If Europe burns, we here in the states will feel the flames. The U.S. and European economies are deeply interconnected commercially and financially. Although domestic banks and money-market funds had fairly limited exposure to Greece, they are far more vulnerable to debt crises in Italy and Spain. And as we learned three years ago, rising losses and spreading fear can cause lending to seize up in a flash, stifling global growth.

This could get really ugly fast.