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.