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Eastern Europe, Subprime Borrower

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EU could face possible collapse.

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Judging by the papers this morning, the world has finally woken up to the fact that Eastern Europe is the subprime borrower for Western Europe. And at the risk of beating a dead horse, these nations do in fact have very similar characteristics of high leverage and weak incomes.

I would also draw your attention to 2 recent announcements from Moody's:

Late last week, the ratings company split its AAA sovereign borrowers into 3 groups: resistant, resilient and vulnerable. In the strongest category (resistant), Moody's placed the following European governments: Germany, France, Austria, Finland, Luxembourg, the Netherlands, Norway, Denmark and Sweden.

In a special comment on Tuesday, Moody's warned that banks -- notably in Austria, France, Italy, Belgium, Germany and Sweden -- with significant exposures to East European economies may be downgraded.

Looking at the 2 lists, there's clear overlap - Austria, Germany, France and Sweden, arguably the strongest economies in the EU. But, more importantly, countries who have already demonstrated an explicit linkage between domestic bank credit-worthiness and sovereign support.

But I would offer that these 4 countries, along with a few other major European nations, face a very real and looming Sophie's (or should I say Nicholas and Alexandra's) choice – either help bail out their troubled EU brethren, and thereby risk burdening their own domestic economies with significant new debt; or let the other nations fail, and risk the collapse of the EU.

Now, I'm sure there are some reading this who would say there is no choice - the strong must save the weak. But I would offer that, in this environment, that may be too quick a conclusion - one need only look at what's happened to Bank of America (BAC) and Wells Fargo (WFC) in the aftermath of their bailouts of Merrill Lynch and Wachovia, respectively.

Ordinarily, size and reputation would delineate the strong from the weak. But in these turbulent times, a great many lifeguards can be, and are, drowned each year trying to save drowning swimmers. (That's why, here in the US, there will be no more large scale bank mergers.)

Several months ago, I was asked why, with the exception of Northern Rock, there have been no bank runs. In response, I offered: If governments learned anything from the Great Depression it was how to manage troubled banks. But I also suggested that governments around the globe, by stepping in so aggressively, may inspire not bank runs, but country runs. In our "1-click world," money can move not just out of banking institutions but out of entire nations. We have already seen at least one example of this - Iceland.

I don't profess to know where the road we're on is leading us. But with each passing day, the stakes are mounting, and the consequences of the choices ahead are daunting.
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