Investors, perhaps spooked by the 50% write-down in the face value of privately held Greek debt, want to hear that Italy is being fully backed and supported by its colleagues and partners. So far, however, that is a message that Germany, let alone France, is unwilling or unable to deliver.
And of course the fear in Paris is that France will be next. Mr. Sarkozy's government just announced another set of budget cuts and tax increases in the face of lower growth, so as to keep to its promises to cut its own budget deficit. But on Wednesday, the spread of 10-year French government bonds over their German equivalent rose to a eurozone high of around 140 basis points. "Contagion" is not just a movie.
What if Italy's newly issued bonds won't sell?
Following 5 days of persistent refusals to deal with reality, the real world finally came back with a bang, and while the overall market tumbled the most it has in two months, it is really financial stocks that took the brunt of today's beating. Most major U.S. banks are on the ropes. The reason? Italy of course, and the fear that once the country is forced to write down its debt, the bank failures will proceed in waves: first Italian banks, then French, and then everyone else (according to ZeroHedge.com), especially those that have already been in the market's crosshairs because of their exposure. And if today was ugly, tomorrow promises to be an absolute bloodbath with Italy deciding to proceed with the issuance of $5 billion in 1 year Bills into what may well be a bidless market.
Just as the collapse of the U.S. housing market three years ago and Wall Street's subsequent credit crunch sent shock waves around the world, federal officials in the U.S. fear that the European debt crisis could hurt big banks there and trigger major problems here, perhaps dragging the U.S. into another major recession or worse. "Like Europe was vulnerable in the crisis of '08, the U.S. is vulnerable now," said Nicolas Veron, a senior fellow at the Bruegel think tank in Brussels. "At this point, there are big risks in Europe."
As Jim Puzzanghera reported a couple of months ago in the Los Angeles Times, many banks (including U.S. banks) are saddled with large holdings of bonds from troubled nations such as Greece, Italy and Spain, but regulators in the decentralized European Union have less power (than their counterparts in the US) to stem a crisis, should it arise. (And it is now arising.)
U.S. officials have been worried about the potentially toxic combination of soaring sovereign debt from some key European nations, and exposure to it by banks there that have not been required to buttress their finances sufficiently.
Sheila Bair, former chairwoman of the Federal Deposit Insurance Corp., warned lawmakers way back in June that problems in Europe made the prospects of further banking problems in the U.S. "unsettlingly high."
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