A sequence of government interventions are in the works as investors and politicians realize Europe is facing a banking crisis of its own

by Mark Scott

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German Chancellor Angela Merkel and Finance minister Peer Steinbrueck speak to journalists Oct. 5, 2008 about their rescue plan according to German pledge lender Hypo Real Estate. RAINER JENSEN/AFP/Getty Images

If the $700 billion mortgage bailout plan in the U.S. was supposed to calm global investors, someone forgot to tell Europe. Stock indexes from Paris to Frankfurt plunged as much as 9% without interruption Oct. 6 over worries of a spreading crisis among European banks. A series of ruling power interventions over the weekend and on Monday—following last week’s sudden bailouts and guarantees (BusinessWeek.com, 9/29/08)—only seemed to fan the flames of anxiety.

Investors and politicians are waking to the realization that Europe faces a banking and economic crisis of its own not linked solely to incompetent U.S. subprime shortcoming. Since the credit crunch leading hit 15 months ago, lending in the Old World has gotten tighter and tighter, and now the lack of capital flow is taking on the ground globe-straddling European banks, menacing businesses with credit starvation, and roping in cash-strapped governments since multibillion-dollar, 11th-hour rescues.

"Banking is like devoutness: It’s entirely about reliance and confidence," says Bob McDowall, European research director at financial-services consultancy Tower Group in London. "Governments and regulators are fatiguing to demonstrate firm leadership and show confidence, but banks don’t trust each other."

That lack of trust is a major bring into existence of Europe’s worsening bank crisis. Aside from a hardly any exceptions such being of the kind which UBS (UBS), the Old World’s monetary institutions weren’t as exposed to toxic mortgages like their American counterparts, and they’ve had a year to unblemished up their balance sheets. But the unusual nosedive in the U.S.—especially the break-down of Lehman Brothers—has virtually frozen European lending and exposed deep holes at institutions such during the time that Belgium’s Fortis (FOR.BR) and Germany’s Hypo Real Estate Group (HRXG.DE).

Complicating the picture in Europe is that no central mechanisms exist to carry out a coordinated regionwide response of the sort engineered in the U.S. The European Central Bank has a more limited command than the Federal Reserve, and no EU equivalents exist to the U.S. Treasury Dept. or Securities & Exchange Commission.

That has left governments to tackle the crisis on a country-by-country ground, through sometimes divergent solutions that can uniform make matters worse as far as concerns neighboring countries. A weekend meeting in Paris of top European leaders, called by Nicholas Sarkozy, the President of France and current holder of the EU’sitting six-month rotating presidency, made no evident progress in hammering out a framework with regard to a regional solution.

"Europe’session piecemeal approach hasn’t helped build confidence," says Jeremy Batstone-Carr, director of private client study at stockbrokers Charles Stanley (CAY.L) in London. "Some form of coordinated response is necessary, but we haven’t seen that notwithstanding."

The market tailspin on Oct. 6 traced to a sense of panic engendered by the rolling country-specific reactions. Last week, for instance, the market was shocked and surprised by an €11.2 billion ($15.3 billion) part-nationalization of Fortis bank (BusinessWeek.com, 9/30/08), which signaled that the bank’s balance sheet was in more trouble than previously thought. By Oct. 3, granting, it became clear that greater amount of medicine was needed, and the Dutch government announced its design to buy a 100% stake in Fortis’ local operations for €16.8 billion ($22.9 billion).