Financial Crisis Spreads to Europe, Beyond

Another weekend of drastic government interventions in troubled European banks eclipsed any potential benefit from the U.S. passage of the $700 billion financial-services bailout, underscoring the global dimension of the crisis.

Markets world-wide plunged as the Dow Jones Industrial Average sank below 10,000 for the first time since 2004, following a series of events in Europe that illustrated the stark divide between the eurozone's unified central banking and currency framework and the divergent policy responses of national governments. The problems are national and regional, but the effects are global.

London's FTSE Index dropped 7.8% Monday, its worst one-day drop since the U.S. crash of 1987. Germany's DAX closed down 7.1%, while the benchmark Nikkei 225 Stock Average on the Tokyo Stock Exchange hit a four-year low. In emerging markets, Russian indexes saw multiple trading halts and China saw the already battered Shanghai Composite index fall about 5.25%. Even the Toronto Stock Exchange saw a decline of as much as 10% in it main index in early Monday trading.

In less volatile circumstances, a bunch of European Central Bank officials huddling with finance ministers in Germany, Iceland and Italy would induce snores from U.S. investors, but these aren't ordinary times. The end of easy credit has jammed the wheels of commerce on a global scale, and investors everywhere are discovering the downside of globalization.

"What's going on is that we are in a global recession," says Nancy Lazar, economist and vice chairman at ISI Group. "We were like a drug addict, depending on a lot of credit. And that credit is being shut down, and shut down fast. As a result economic activity is shutting down fast, and because Europe as a whole is about the same size economy as the U.S., this is going to put even more pressure on some developing economies. This is, in effect, a new world."

Over the weekend, German Chancellor Angela Merkel one-upped the FDIC, which will boost deposit insurance to $250,000 from $100,000, and guaranteed all retail banking deposits after problems at Hypo Real Estate, Germany's largest mortgage lender, threatened to undermine confidence in the country's banks. Sweden, Austria, Denmark, Ireland and Greece have also guaranteed retail deposits.

The U.K., French, German and Italian heads of state met in Paris over the weekend for a hastily arranged discussion of credit and banking challenges, says Jon Levy, an analyst at the Eurasia Group political risk consultancy. Previously, some French officials had floated the idea of assembling a standing EU-wide fund that could be used for bailouts, but the plan failed to drum up wide support.

"The events in America over the last few weeks -- and in Europe over the last few days -- have again demonstrated the global nature and sheer scale of the problems affecting the global financial system," said Alistair Darling, the United Kingdom's Chancellor of the Exchequer, in a Monday speech to the House of Commons. The U.K. government last week was forced to nationalize the mortgage business of failed bank Bradford & Bingley and parcel the remaining operations off to Abbey National, part of Spanish banking group Santander.

"Europe was assumed to be pretty solid by many investors, and now Europe is in a much more difficult position for fixing its bank problems," ISI Group's Lazar says. "There's not just one authority as there is in the United States."

The scope of the crisis is now so vast -- and bad news is flowing at such a high rate of speed -- that even staunchly bullish market watchers such as Ed Yardeni of Yardeni Research feel the brakes should be applied.

"Government insurance to back up all deposits and bank debts may also help boost confidence in global banking systems," he wrote Monday.

Perhaps those measures will have some impact but negative momentum overrode the possibility of immediate benefits. And there's a tightening circle at work here: European banks are affected by problems at their U.S. counterparts, and that in turn affects U.S.-based multinationals that depend on those markets for growth.

This is partly because European policy makers and banking executives have approached their version of the crisis with the same unsuccessful piecemeal responses the U.S. tried in previous weeks. The AIG (AIG) bailout, the seizure of Fannie Mae (FNM) and Freddie Mac (FRE), the bust-up of Lehman Brothers and Bear Stearns, and the sale of Merrill Lynch (MER) all illustrated the inadequacy of small-scale responses.

Lazar says a rate cut by the European Central Bank would be welcome news and help align the effects of Europe's varied national governmental interventions. Jean-Claude Trichet, president of the ECB, has historically been slower to change rates than the Federal Reserve, but Lazar says there's usually some corresponding move, and she wonders why it hasn't happened yet.

"In January 2001, we eased, and then they eased in May, against a similar economic background," she says. "Now you need policy makers to respond, to do more, and the ECB needs to do more -- and fast."

But a careful look at what's happening shows some interesting patterns within the FTSE Global Equity Index Series. Jerry Moskowitz, president of FTSE Group America, an index provider, says that while financial stocks are hurting, natural resource-related companies are taking far bigger hits.

"These indexes reflect not only a financial panic, but a huge pullback from natural-resource companies," he says.

That's important to realize, says Jonathan Auerbach, managing director and co-founder of Auerbach Grayson, an institutional brokerage that trades foreign securities for its clients. If Monday was a time of panic, he sees the next couple of weeks as a time of opportunity for global investors.

"I think we're within a week or two of some form of capitulation -- meaning we're seeing so much selling that we'll reach a real benchmark oversold level," he says. "We still see situations we think are interesting, but I'd be hard-pressed to go out and push a lot of names right now."

Eurasia Group's Levy says a lag between policy intervention -- in the U.S. and abroad -- and equity-market recovery is to be expected, given the buildup to the crisis and the manner in which its effects have spilled into world markets.

"If nobody was able to quantify the risks, it's going to take some time to quantify the damage," he says.