Italy, Spain, Greece, and some other European nations are straining to meet debt payments. Should they default, European banks that hold their bonds would suffer. Wall Street's fear is that the contagion would imperil U.S. banks that do business with those European banks.
French banks, with huge amounts of Italian and Greek government debt, are especially vulnerable. Shares in Societe Generale, France's No. 2 bank, plunged nearly 15 percent Wednesday on rumors it was teetering under the weight of debts tied to troubled Eurozone economies. The bank rejected the rumors as unfounded and irrational.
On Thursday, Societe Generale's stock recovered 3.7 percent. Most other European banks fell sharply.
Using data from European Union stress tests on 91 European banks, Fitch Ratings said direct losses of 50 percent on Greek bonds and 25 percent on Portuguese and Irish bonds wouldn't have made any of four big French banks flunk the test.
Still, investors in the United States and Europe were rattled this week by fears that French government debt was about to be downgraded by a credit-rating agency. Without France's AAA credit rating, Eurozone countries might be unable to raise the money needed to bail out their weaker neighbors.
What frightens investors most is the worst-case scenario - the one that struck Wall Street in 2008: That banks will stop lending among themselves because they're worried about one another's solvency. Since July 21, JPMorgan Chase's stock price has dropped 13 percent. Citigroup's has sunk 25 percent.
Major international banks are so intertwined that once they lose confidence in one another, fear spreads rapidly. And once it does, investors tend to panic and send stock markets plunging.
Rumors like the ones that pummeled Societe Generale and raised fears about France's creditworthiness are "what panics are made of," says William Longbrake, former chief financial officer at Washington Mutual and now executive in residence at the University of Maryland.
In 2008, "Banks were suddenly afraid to lend to each other because they had no trust in . . . other institutions," Longbrake said. "What happened yesterday in France is indicative of the same situation."
