The 'Subprime of Europe'

Dropping terms such as "financial Gotterdammerung" and "monetary Stalingrad," business media around the world today have recently rung a new alarm bell: Eastern Europe's $1.5 trillion of debt is in trouble.

How did things get to this point? We'll have more about this on Monday's podcast. For now, a brief look at a story that seems all too familiar.

 

The crisis has unfolded rapidly this week. First, governments in the former Soviet bloc became at risk of defaulting on their debt — more on that after the jump. Next, Moody's issued a report saying that Western European banks have loaned significant amounts to consumers in Eastern European, money they may not be getting back.

Just as easy credit and the illusion of perpetual growth sucked investors into a real estate bubble in the U.S., over the last several years Eurozone banks were lured into the former Soviet bloc. The banks were able to borrow cheaply at home and lend at high rates abroad, in places like Poland. The banks made a killing, profiting enough to get some shelter from last year's devastating collapse.

Now analysts are calling the boom the "subprime of Europe" — rapid growth in the consumer economy, fueled by heavy borrowing.

As the global recession deepens, consumers and governments are having a hard time keeping up with the payments. Demand for Eastern European goods and services has dropped so low that the value of the Czech koruna, Polish zloty and Hungarian forint have dropped to three-year, five-year and all-time lows against the Euro. Bank runs have made matters worse. (See here for an explanation of the relationship between a country's currency and its economy.)

Western banks are having to pay much more to insure their debts through credit-default swaps. They're expected to pull money out of these economies, cutting off the loans that make it possible for businesses there to expand. Eighty percent of the assets in Eastern (or "emerging") European banks are actually owned by Western European banks.

Which Western countries are in most trouble? Austria is the most exposed to Eastern European credit; it's owed an amount equal to 70 percent of the country's GDP. However, even the government of Switzerland, long associated with financial stability, faces the threat of bankruptcy because its franc was so popular with Eastern European borrowers.