The situation in Europe is hitting global credit markets, making it harder for companies and banks to secure loans. Investors are buying fewer corporate bonds, and banks are finding it more difficult to borrow from each other. On Thursday, as the European Central Bank again resisted pleas for it to rescue the eurozone, worries about a severe credit crunch along the lines of the 2008 crisis grew.
"In some ways this is part two of the U.S. financial crisis," said Srinivas Thiruvadanthai, an economist at the Jerome Levy Forecasting Center.
Credit rating agency Fitch Ratings downgraded nine major banks on Thursday, including Goldman Sachs, Bank of America and Morgan Stanley. While acknowledging that the banks are in better shape now than in 2008, the rating agency cited vulnerability to the increased market turmoil stemming from "economic developments and regulatory challenges."
Many fear that one cataclysmic event -- such as the default of Italy or a major European bank failure -- could freeze credit markets, plunging the world into a recession similar to the downturn resulting from the bankruptcy of Lehman Brothers in 2008.
"As the situation in Europe goes, so does the global economy," said Adrian Miller, fixed-income strategist at Miller Tabak Roberts Securities.
Miller said that the bond markets have been moving in sync with the European crisis; recently he's noted that investors are growing wary of lending even to so-called safe businesses. Global investors are buying about 40 percent fewer new high-quality U.S. corporate bonds than in mid-May, according to Miller. Meanwhile, there's been about a 70 percent plunge in the purchasing of new, risky U.S. corporate bonds: While global investors bought about $8 billion of these bonds per week in mid-May, now they are buying just $2.5 billion.
As European banks slash lending in order to meet new capital requirements, European companies have been hit somewhat harder. Purchases of newly issued risky European corporate bonds have plunged about 80 percent since mid-May, according to Miller.
Banks also are finding it harder to borrow from one another. It is now more than twice as expensive to secure a three-month loan from another bank than at the beginning of August, according to Rich Gordon, managing director of fixed-income market strategy at Wells Fargo Securities.
On Thursday Fitch downgraded Bank of America and Goldman Sachs' long-term debt to A from A+, Barclays' long-term debt to A from AA-, BNP Paribas' long-term debt to A+ from AA-, Credit Suisse's long-term debt to A from AA-, and Deutsche Bank's long-term debt to A from AA-.
The downgrades reflect "balance sheet damage" emanating from the increased riskiness of European sovereign debt, but they would not result in any major economic repercussions, said Michael Spence, a Nobel Prize-winning economics professor at New York University's Stern School of Business. "There has been some significant credit tightening already," Spence said.
He added that the Federal Reserve ultimately would step in if credit markets dry up. "If left unattended, it will cause some damage, but I don't think it will be left unattended," he said.
In a speech in Berlin on Thursday, European Central Bank President Mario Draghi disappointed investors when he repeated that the bank would not come to the rescue and step in to buy large amounts of government bonds. "There is no external savior for a country that doesn't want to save itself," Draghi said. In an attempt to reassure the audience and jittery investors across the globe, Draghi said that "a return of confidence," stemming from government budget cuts, likely would materialize and mitigate the economic damage of austerity measures in struggling countries.
Observers were not reassured. "There isn't any likelihood of it [confidence] returning," said Jay Bryson, global economist at Wells Fargo Securities. Bryson added that the ECB is the only organization with the firepower to save European countries and banks from default, and that ultimately when it seems to have no other choice, it will most likely step in.
"Authorities at least in the past have always blinked, or generally have always blinked," Bryson said.
Markets slightly recovered but remained cautious on Thursday after the previous day's turmoil. The interest rate on 10-year Italian government bonds fell slightly but remained above the unsustainable 7 percent level. Russian leaders said that they would step in to help, indicating that the country would lend more than $10 billion to the International Monetary Fund, as a backstop for struggling European governments.
Europe's troubles first came to light in 2010 when Greece's debt troubles caused a financial panic. And the situation continues to evolve, reminding some of the slow motion pace of the U.S. housing market collapse, which took hold in 2007 and triggered the financial crisis in 2008.
After Lehman Brothers declared bankruptcy in September of that year, banks stopped lending to each other, fearful that more failures were coming. Banks hiked the cost of their loans to other banks (like they're doing now), making it more difficult for banks to come up with the capital necessary to cover all of their liabilities. Meanwhile, as more investments in the housing market fell apart, banks were forced to pay out insurance on those mortgage defaults. But they didn't have the money.
Companies that relied on short-term financing to maintain their daily operations found themselves on the brink of shutting down, as loans became prohibitively expensive. Major banks were about to fail.
After the U.S. Treasury and Federal Reserve rescued the U.S. banking system from collapse, credit remained tight in 2009, and companies that were unable to secure loans ended expansion plans and laid off workers, reducing consumer demand and worsening the economy. That forced companies to cut even more workers and making lending even tighter.
Though the vicious cycle of layoffs and reductions in lending has ended, it could resume again if the crisis in Europe spirals out of control with a default by the Italian government, said Stijn van Nieuwerburgh, associate finance professor at New York University's Stern School of Business. "As banks become less and less solvent, or their bottom lines are hit, they'll be less inclined to do risky lending," he said.
Catherine New contributed reporting.