Wenning Advice

Put together a union of strong countries like Germany and weak countries like Greece and what will happen?  Will the weak countries learn from the strong ones and become fiscally responsible?  Or will they expect the strong countries to support them and drag them down in the process?

The later appears to be the case in Europe, where sovereign debt contagion has spread from Greece, Italy, Spain, Portugal and Ireland to threaten the European banking system.

Many European governments have spent recklessly and even attempts to keep the crisis from spreading are being met with wide resistance.  Once a government entitlement is given, it is difficult to take it away.

The crisis goes well beyond government spending.  As Stratfor Global Intelligence recently noted, while attempts are being made to control sovereign debt, “all of the broader problems of overcrediting, housing markets, pensions problems” are not even being addressed.

But the sovereign debt crisis and the European banking crisis are joined at the hip.  The severity of the problem was made evident by the October collapse of Franco-Belgian bank Dexia, which agreed to nationalize its Belgian banking business in exchange for a 90 billion euro ($121 billion) bailout.  Austria has also seen a couple of bank failures, and banks in France have also been reported as being in trouble.

Stratfor believes that “Europe’s banks are as damaged as the governments that regulate them.”  The firm’s analysis notes that, “As a rule the largest purchaser of the debt of any particular European government will be banks located in the particular country. If a government goes bankrupt or is forced to partially default on its debt, its failure will trigger the failure of most of its banks.”

In Europe, banks are more highly regulated and are more dependent on the government than in the U.S.

“You have got the states, who have the banks beholden to them, they are able to twist the arms of the bank executives and force them to do things they would not otherwise do,” according to Stratfor Vice President of Analysis Peter Zeihan.  “Banks just are not willing to challenge the regulators, and so you probably will be able to get a significant buy-in that is voluntary, although not very voluntary.”

And just as European banks are dependent on their government, the European economy is deeply dependent on European banks.

“Americans only use bank loans to fund 31 percent of total private credit,” Stratfor notes, “with bond issuances (18 percent) and stock markets (51 percent) making up the balance.  In the eurozone roughly 80 percent of private credit is bank-sourced.”

This interdependence hints at the complexity of the sovereign debt problem, while underscoring just what’s at stake and why all of Europe is so dependent on a solution to the sovereign debt crisis.