Rising economic woes test Europe's leaders

"Such self-fulfilling speculation totally disregards fundamental economic developments in the CEE countries and creates misperceptions that could inevitably be detrimental to both the CEE region and Europe as a whole," the bankers said.

Eastern Europe's wounded

Not all countries east of Germany are failing. Eurozone members Slovenia and Slovakia seem safe, as do euro aspirants Poland and the Czech Republic. Most vulnerable are Hungary; the Baltic trio of Latvia, Estonia and Lithuania; Bulgaria; Romania; and Ukraine. The IMF already has extended multibillion-dollar financial lifelines to Hungary, Latvia and Ukraine, with more wounded countries waiting in the wings.

Hungarian Prime Minister Ferenc Gyurcsány proposed a $240 billion EU bailout fund for the Eastern European countries, but was rebuffed at a March 1 summit. A few days earlier, the World Bank cobbled together a roughly $33 billion package to support bank lending, which IMF Managing Director Dominique Strauss-Kahn hailed as helping "mitigate the effects of the financial crisis on credit flows in the region."

But private sector analysts were dismissive. "It's a first step. But you have to multiply it by 20," said Daniel Gros, director of the Centre for European Policy Studies in Brussels.

Tuesday, the European Union endorsed doubling the IMF's financial war chest to $500 billion to cope with likely rescue needs.

Western banks' $1.7 trillion exposure to the East, measured against the EU's $13 trillion economic output, doesn't appear unmanageable. But because the EU lacks a central treasury, each country's banks, for the moment, are on their own. Austrian banks — notably, the giant Raiffeisen Bank, with operations in 17 Eastern countries — have exposure to the East that is equal to 68% of Austrian gross domestic product.

If losses mushroom on those debts, the Austrian government would be unable to rescue its banks alone. Vienna would have to turn to the EU, where the key player is Germany. And facing national elections this fall, German Chancellor Angela Merkel has resisted telling German voters they must pay to rescue their more profligate neighbors.

"The German decision now is totally suicidal. Their banks are heavily overleveraged. So if they helped Eastern European countries, they would help themselves," says Anders Aslund, an economist with the Peterson Institute for International Economics in Washington.

But if Germany has been slow to rescue the newest Europeans, it might also be because Europe's problems aren't confined to the East. Several smaller EU economies are behaving in ways that suggest to spooked markets they might one day default on their government debts. Investors have lumped the cash-poor candidates under the waggish moniker PIIGS — for Portugal, Ireland, Italy, Greece and Spain. All face the need to borrow growing amounts to cover yawning gaps in their public finances.

In Ireland, the aftermath of an outlandish housing bubble has driven the economy into recession and exposed widespread bad loans by the country's major banks. The plunging economy, in turn, has wrecked public finances. The moribund property market is depriving the government of a critical source of tax revenue, while fast-rising unemployment sends social spending soaring.

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