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The next global economic shock?

Western Europe's banks are too indebted to export-hit Asia and Eastern Europe.

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The economic difficulties in these regions are bound to pressure European finance, where, according to the International Monetary Fund, bank leverage exceeds that of American banking by 50 percent. It is hard to make American banks look prudent, but the Europeans seem to have managed.

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The aggressive nature of European lending has created a particularly difficult regulatory situation should circumstances require a rescue operation, as the American subprime excesses did in the United States. Because European banks are far more extended than American banks are, their governments and even the European Central Bank lack sufficient resources to replace lost capital, as the Federal Reserve and the Treasury are doing in the United States.

In contrast to American banking, which holds assets equal to some 85 percent of US GDP, Eurozone bank assets in total amount to 330 percent of Eurozone GDP. What makes matters still more precarious, these aggregate figures look moderate when compared to the lending ratios of some individual Eurozone members. Irish banks, for instance, took on debt equal to almost 11 times their national GDP. Dutch banks took on debt equal to seven times their national GDP, and Belgian banks took on debt equal to four times their national GDP.

The potentially troubled loans in Eastern Europe and Asia could amount to some 33 percent of Eurozone GDP, a far higher figure than subprime in the United States, which, in the worst calculated scenarios, amounts to some 8 percent of American GDP.

So far, these borrowers, if they have not managed to remain entirely current on their obligations, have paid sufficiently well to avoid the troubles implicit in these comparisons. If, as expected, the American economic situation can stabilize in the second part of this year, and China can sustain an adequate growth rate as it reorients its economy toward a domestic growth engine, there is a good chance that European finance and, by implication, global finance, will avoid the dangers implicit in these great vulnerabilities. But still, for the time being, investors need to recognize the significant risks.

This vulnerability may also explain why the Europeans are so focused on regulation and have chosen to emphasize it above the kinds of fiscal stimulus that the Obama administration has pushed. On the one hand, they want to garner all the resources they have should the banking sector need them at some future date. On the other, the emphasis on regulations might well reflect an urgent need to prevent this from happening again.

Milton Ezrati is senior economic strategist at Lord Abbett, a money management firm.