European markets tremble at confluence of economic worries

European stock markets tumbled Monday on warnings of a broad crisis developing in the region’s financial sector and intensifying doubt about the ability of euro-area politicians to effectively respond.

Major indexes such as Germany’s DAX and the Stoxx 50 of blue-chip companies were down more than 5 percent for the day. Confidence in the health of the region’s banks is falling, economic growth is slowing and governments are so hamstrung with debt that they will have little room to respond with new stimulus or other programs.

An economic downturn in areas that account for much of the world’s trade would be damaging on its own. But a full-blown financial crisis in Europe could have a devastating impact on both sides of the Atlantic.

The financial systems of Europe and the United States are closely intertwined, in ways that would make a major bank failure or loss of confidence in one area ripple through the entire system. The costs that banks pay to fund their businesses would rise, lending would slow and related institutions might also fail because of the complex web of investments that major financial companies often share.

“In a pattern echoing that of the 2007-09 financial crisis, there is a growing risk of the real economy and financial conditions being locked into a mutually-reinforcing downward spiral,” the Institute of International Finance wrote in a paper.

Politically, the signals also were bad. Borrowing costs for Italy jumped Monday as the government there stumbled over how to deliver promised deficit cuts, raising the prospect of what many in Europe consider a doomsday scenario: Italy’s trillions of dollars in outstanding bonds at risk of default, pushing the country toward a bailout that would strain the area’s political and financial capacity.

A defeat Sunday for German Chancellor Angela Merkel’s party emphasized the problems she may have in persuading Parliament to approve new German-funded support for other European governments.

The gloom extended to Asian markets in Tuesday trading. Tokyo’s Nikkei 225 index ended its morning session down 1.23 percent.

A steady stream of recent data has pointed to a slowdown among the developed economies. Euro-area growth all but stopped during the past three months — including in Germany, the region’s economic powerhouse — and a report Friday showed no growth in U.S. employment in August.

Replay of 2008 feared

In a recent analysis of how a financial crisis in one country can extend across borders, the International Monetary Fund said that the threatened collapse of a major European bank would produce a 40 percent probability of similar problems in a U.S. institution — similar to the stress seen during the crisis that followed the collapse of Lehman Brothers in 2008.

The rise on Monday in Italian and Spanish borrowing costs is particularly troubling. The European Central Bank has been intervening steadily in government bond markets to try to hold down the interest rates paid by the two countries, and last week bought an additional $20 billion worth of government securities.

Central Bank President Jean-Claude Trichet and other ECB officials have warned that they consider the bond-buying a temporary measure and have urged the Italian and Spanish governments to convince markets that they can get a grip on public finances.

Italy in particular is considered too big to save, and a threatened default by the country — whose debts are spread deeply throughout the European banking system — would likely cause a profound shock to the global system.

Concern centered on back-room horse trading by Prime Minister Silvio Berlusconi’s government in a bid to make austerity measures politically palatable to his fraying coalition. Italy’s Parliament is supposed to debate the austerity plan Tuesday, and the country’s major union has called for a national strike.

“Italy is still the focal point,” said Elga Bartsch, chief economist with Morgan Stanley in London. But she noted how broad the palette of concerns has become. There are steady rumors that the credit rating not only of Italy but of France may be downgraded, and doubts as well that French President Nicolas Sarkozy can keep the euro area’s second-largest economy on track.

France may be next

Growth in France is also slowing, and the French leader — heading into a tough reelection campaign — recently unveiled a new round of tax increases and spending cuts.

“The question is whether it’s going to be possible to run an austerity campaign in a country known for its resistance to austerity during a presidential election,” Bartsch said.

The defeat by Merkel’s party in a regional election in her home state Sunday compounded Europe’s problems as well. A recently expanded bailout for Greece and a host of other measures must be approved by the 17 national parliaments of the states that use the euro, and the leadership of Merkel — as head of the nation that is funding much of it — is critical.

In addition, Finland remains at odds with other euro-zone nations for demanding collateral from Greece in exchange for rescue loans. Slovakia is now threatening to delay approval.

The thickening set of issues is “a huge, huge problem,” said David Buik, partner at BGC Partners in London. “European leaders need to make up their mind about whether they are finally going to stand together and do what it takes to end this crisis, or simply move toward disbanding the euro, which would exact a price no one wants to pay.”

Faiola reported from London.

Anthony Faiola is The Post's Berlin bureau chief. Faiola joined the Post in 1994, since then reporting for the paper from six continents and serving as bureau chief in Tokyo, Buenos Aires, New York and London.
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