European governments scramble to protect banks

— -- The Irish government Tuesday issued a blanket guarantee of its threatened banks, the latest sign that the U.S. financial crisis is wreaking havoc overseas. Irish officials moved swiftly to stem a looming loss of public confidence, deciding within hours to expose taxpayers to a potential 400 billion euro liability, not much less than the proposed $700 billion U.S. bailout that is drawing prolonged debate in Washington.

"It's a panic," says economist John Fitzgerald of Dublin's Economic and Social Research Institute.

Across Europe, governments are scrambling to safeguard banks, many saddled with now-toxic U.S. mortgage-related securities. Tuesday, the Belgian and French governments teamed in a $9.2 billion bailout of cross-border lender Dexia. The rescue came one day after the Belgian government joined with its Dutch counterparts to save Fortis, one of Europe's 20 biggest banks.

"It was essential to recapitalize Dexia to ensure the stability of the financial system," French Finance Minister Christine Lagarde said, according to Reuters. Growing worries about European banks put pressure on the euro, which suffered its largest one-day fall against the dollar since its 1999 introduction, and drove interest rates on loans between banks to record highs. The euro ended trading at $1.41, down more than 2%.

In a reflection of growing credit market woes, the three-month European Interbank Offered Rate, a measure of what banks charge each other to borrow, hit 5.27%, up from 3.72% in early 2007.

After a flurry of bank rescues organized this week by shifting alliances of European governments, concern remains that a large continental institution may require saving. Several large banks are judged effectively too big to fail — and too big for any one government to save, says Daniel Gros, director of the Centre for European Policy Studies.

Germany's Deutsche Bank, Barclays of the United Kingdom and the French bank BNP Paribas, for example, all have enormous lending and investment operations balanced atop relatively narrow capital bases, he said. By one measure, total assets divided by shareholder equity, the largest European banks are almost twice as highly leveraged as their U.S. counterparts, Gros said.

European banks with substantial operations in the U.S., such as Deutsche Bank, could benefit from the proposed U.S. financial rescue plan. But continued piecemeal rescues are doomed, he says, likening Europe's financial landscape to where the U.S. was about six months ago.

Ultimately, Gros says Europe's banks will need a sizable capital infusion. He puts the likely tab at more than $360 billion to restore the 10 largest institutions to fiscal health.