Gloom Spreads as Europe's Debt Crisis Deepens

BERLIN (May 5) -- In an atmosphere eerily reminiscent of the frenzied days surrounding the Lehman Brothers bankruptcy in 2008, European leaders warned that the Greek debt crisis could spread as financial markets went into a tailspin.

Just days after European Union leaders and the International Monetary Fund agreed a $142 billion rescue package to prevent Greece from becoming insolvent, doubts are mounting that the aid is sufficient to stem a broader crisis.

Investors sold off stocks and rushed into U.S. and German bonds, and the euro tumbled against the dollar Wednesday to a 14-month low.

As Greek rioters set a bank on fire in Athens, killing three people trapped inside, it seemed uncertain that the Greek government would be able to muster the popular support need to carry out radical austerity measures that aim to cut public spending enough to get the country's runaway debt under control.

Greek police clash with demonstrators in front of a government building on May 5 in Mytilene, Greece.

Uriel Sinai, Getty Images

Police clash with demonstrators in front of a government building in Mytilene, Greece, on Tuesday.

German Chancellor Angela Merkel issued a strong appeal to lawmakers in Berlin to back the government's pledge to contribute some $28 billion to the Greek aid package.

"The future of Europe is at stake," Merkel told parliament at the beginning of three days of deliberations over the Greek aid package. "Europe is standing at the crossroads."

Around Europe, the mood was no less gloomy than in Berlin. In Brussels, the EU's monetary affairs commissioner, Olli Rehn, warned that Europe could slip back into recession if it did not act decisively to stem the contagion.

"It's absolutely essential to contain the bushfire in Greece so that it will not become a forest fire and a threat to financial stability for the European Union and its economy as a whole," he told a news conference.

Merkel's foot-dragging over the past month about whether to participate in a Greek bailout is one reason the situation has become as tense as it is now, analysts say. Merkel was originally keen to put off the discussion of aid until after a crucial state election on Sunday. She changed her strategy this week as her handling of debt crisis caused her approval rating to drop six points to 48 percent, according to a Forsa poll published this week.

Signs of contagion are already rampant. The cost of debt for the Portuguese government surged Wednesday, with interest rates for six-month government bonds shooting up to 2.955 percent from just 0.74 percent in March.

The international ratings agency Moody's put Portugal on review for a downgrade, following its move last week to cut Spain's rating amid warnings that further downgrades could follow if Spain did not take measures to cut its deficit.

The Spanish government is expected to sell debt Thursday, according to news agency Bloomberg. The sale will be watched closely as an indication of market sentiment. Spain's prime minister, Jose Luis Rodriguez Zapatero, denied Tuesday that his country would also seek a bailout.

Germany remains the linchpin in keeping Europe's disorganized defense against a spreading debt crisis intact.

Apparently concerned about the fate of the euro currency should Germany take too long to ratify the Greek rescue package, Axel Weber, a member of the monetary council of the European Central Bank, endorsed Germany's contribution to the bailout. He said the economies of Spain and Portugal were expected to grow and their governments were acting to avoid a debt crisis, but warned the crisis could spread.

"There is a threat of grave contagion effects for other member states in the monetary union and increasing negative effects feeding into capital markets," Weber said in a statement. "All in all, Germany's contribution to the aid package for Greece is justifiable."