How the Crisis Is Hitting Europe

Its economy harbored far more risk than most people realized, and businesses are more in hock than their U.S. counterparts

By Jack Ewing

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Brian Cronin

As Prime Minister of the German state of North Rhine-Westphalia, Jürgen Rüttgers wanted to save one of his industrial state's biggest employers. So what did he do? He hopped a plane to Detroit, of course. On Feb. 18, Rüttgers met with General Motors (GM) Chief Executive Rick Wagoner in an effort to persuade him not to shutter a factory in the city of Bochum, where 5,000 workers make sedans and minivans carrying GM's Opel badge. Rüttgers returned with little more than a weak assurance that GM has no plans to close any Opel factories—yet.

Rüttgers' pilgrimage to the Motor City says a lot about the way the global downturn has unfolded in Europe. In the U.S., the trouble started with subprime mortgages—a problem that barely exists in Europe. But that hasn't kept the region from falling hard and fast, exposing just how tightly Europe's fate is linked to events in the U.S. and the rest of the world.

Not so long ago, Europeans thought they had dodged the worst of the financial meltdown. Now the region is suffering its first recession since the introduction of the euro a decade ago. In Spain and Ireland, corporate bankruptcies have doubled since 2007, and they're up 11% on the Continent as a whole. Across the European Union, unemployment hit 7.4% in December, vs. 6.8% a year earlier. And output in the euro zone countries could fall by 2% this year, the International Monetary Fund predicts—a bigger decline than the 1.6% contraction in the U.S. "No one, including us, expected the crisis to be so severe," says Siemens CEO Peter Löscher.

The Continent's banks may not have written subprime mortgages, but it turns out they financed something worse: subprime countries. The former communist East is sinking into recession as Western banks choke off the easy credit that fueled Asian-style growth. Now, some pundits say, the former Soviet bloc countries are headed for a crisis on the scale of Asia's in 1997 and 1998.

And how about subprime companies? European corporations are deeply in hock, with $801 billion in corporate debt maturing this year—nearly one-third more than in the U.S. Some, such as Munich-based chipmaker Qimonda (QMNQ) and Swedish automaker Saab, say they are insolvent (page 5). A glut of debt-fueled private equity is proving to be a curse for others. Dutch petrochemical group LyondellBasell Industries sought bankruptcy protection for its U.S. operations on Feb. 9, just 14 months after buying Houston-based Lyondell Chemical in a $19 billion debt-financed deal.

Just as in the U.S., the collapse of Lehman Brothers last August helped send Europe into a nosedive. Stock markets tumbled, credit markets seized up, and business confidence plummeted. But the crisis also demonstrates that the European Union's economic problems are almost as diverse as its 27 members, ranging from slumping exports in Germany and Eastern Europe to anemic consumer spending in France to property bubbles in Britain, Ireland, and Spain. "It's the first downturn that affects the whole world with such violence," says Léo Apotheker, co-CEO of German software maker SAP (SAP).

Meanwhile, there's no single government to fashion a coherent rescue plan. Only the European Central Bank (ECB) has broad powers over the region's economy, and it has fewer policy tools than the U.S. Federal Reserve. Before the introduction of the euro a decade ago, a country such as Spain could have let its currency fall to make its cars, wine, olive oil, and other goods more attractive to foreigners. That's not an option anymore. Instead, as Europe's highfliers are laid low, companies must cut wages to regain competitiveness. "People aren't aware that monetary union requires new ways to adjust to a recession," says Fernando Ballabriga, an economics professor at the ESADE business school in Barcelona.