Europe's debt crisis: 5 things you need to know

                                               
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       NEW YORK (CNNMoney) -- It's been about 18 months since the sovereign debt crisis in Europe began attracting attention in global financial circles.


In that time, the crisis has grown into the biggest challenge the European Union has faced since the adoption of the euro as its single currency 12 years ago.

PrintGreece, Portugal and Ireland are on life support. Italy and Spain are exhibiting worrying symptoms. Germany and France, the healthy ones, are suffering from a global economic malaise.

As the situation appears to be coming to a head, again, here are five key issues to keep an eye on.

1. Stability fund is not very stable

In July, European political leaders announced a set of proposals to address the crisis, including a second bailout for Greece, which was teetering on the verge of default.

The centerpiece of the July 21 agreement was the proposed expansion of the European Financial Stability Fund. The fund was set up last year to facilitate low-cost loans for struggling EU members including Portugal and Ireland.

Under the proposed changes, the fund would be able to buy government bonds directly from banks and investors. Importantly, it would be able to do this for nations that do not already have bailout loans, such as Spain and Italy.

The goal is to contain the crisis by limiting volatility in the sovereign debt markets, where nervous investors have driven borrowing costs for several struggling EU nations to record highs.

But many analysts say there is not enough money in the 440 billion euro fund to be effective if Italy and Spain need to be rescued.

The proposed bailout and stability fund reforms need to be ratified by the governments of all 17 nations that use the euro as their currency.

Over the next few weeks, the measures will be voted on by several EU nations, including those where voters are suffering from so-called bailout fatigue.

The German Parliament is set to vote on the measures Sept. 29. Austria and the Netherlands are also expected to vote on the proposals soon.

2. Greece and Italy are on a knife's edge

In addition to expanding the stability fund, eurozone leaders agreed to provide another 109 billion euro package of low-cost loans for Greece.

Like the stability fund reforms, the second bailout must be approved by all individual euro area governments.

The move initially eased concerns that Greece would default on its debts. But those fears resurfaced in September amid signs that Athens may not meet some of the conditions necessary to obtain its latest installment of bailout money.

What's more, the agreement has already shown signs of cracking.

Finland and Greece reached a controversial agreement in August for Athens to provide cash collateral against loans from Helsinki.

The move resonated with other eurozone nations that have relatively health economies, including Austria and Belgium, which also called for collateral.

Eurozone officials have chafed at the bilateral agreements, since they mean Greece would have to put up cash in order to get cash. Jean Claude Junker, president of the Eurogroup, said finance ministers are working on an alternative plan, but the situation remains murky.

Meanwhile, investors have also been growing worried about Italy.

The third-largest economy in Europe, Italy is considered too big to fail. While the nation has a relatively small budget deficit, Italy has debts equal to nearly 120% of its gross domestic product.

At the same time, Italy's decade-long economic slump is not expected to end anytime soon, making it difficult for the nation to pay off its debts.


has proposed a series of austerity measures aimed at reducing its debt burden. But investors remain nervous about the government's ability to implement the unpopular belt-tightening.

3. Banks are under heavy pressure

Investors are afraid big European banks, which hold billions of euros in sovereign debt on their books, may be forced to take painful writedowns if governments cannot repay their debts.

Société Générale (SCGLF), one of the oldest banks in France, has been at the forefront of investors' worried minds. The company's stock price has plunged to its lowest level since early 2009, when the financial crisis was in full swing.

Moody's downgraded SocGen and Credit Agricole, another major French bank, on Sept. 14.

Moody's said the downgrade was based on concerns about the banks' liquidity, particularly considering the difficulty they'll have getting financing in the current environment.

On the upside, the rating agency said the banks would be able to absorb losses on bonds issued by Greece and other troubled euro area nations. Moody's action came one day after Société Générale defended its liquidity position.

EU officials have also maintained that stress tests conducted in July prove that European banks have sufficient capital.

And there is always the ECB, which has already provided some relatively small loans to European banks. But given the challenging stock market and concerns about a pullback in interbank lending, banks in Europe appear to have few options to raise capital.

4. Economy is in the dumps

Economists say the weaker members of the eurozone will not be able to repay their debts and live without bailouts until economic activity resumes in a big way.

That seems unlikely given the outlook for economic growth in Europe and around the world.

The ECB recently lowered its forecast for economic growth across the eurozone for this year and next.

The central bank now expects growth of only 1.4% and 1.8% in 2011, and between 0.4% and 2.2% in 2012.

Both are down from earlier forecasts, and the risks to that gloomier outlook are now to the downside, rather than balanced as the ECB had previously said.

In the second quarter, overall economic activity among the 17 nations that use the euro grew only 0.2% compared with the first quarter, according to Eurostat.

Germany, the region's economic powerhouse, reported a paltry 0.1% increase in second-quarter gross domestic product, compared with a more robust 1.3% in the first quarter. But economists say Germany is still on track for modest growth in 2011.

The German economy is heavily dependent on exports and has benefited from rapid growth in emerging nations such as China.

As activity cools in those markets, the outlook for Germany has dimmed. The slowdown raises troubling questions about the long-term outlook for the eurozone.

5. Fate of eurozone is at risk

The crisis has brought to light problems that many analysts say will require a fundamental change in the way the European Union operates.

The eurozone nations have enjoyed the benefits of a shared currency and uniform monetary policy since about 1999. However, aside from certain unenforced budget targets, the group has never had a common approach to fiscal policy.

The lack of coordination has resulted in a situation where stronger members of the union are now being forced to help support less competitive members that have spent beyond their means.

If they don't, many analysts say the union could break up, with one or more nations abandoning the euro.

European leaders have said repeatedly that they will do whatever it takes to preserve the euro, arguing that greater economic integration is the key to doing so.

Can more debt help Europe?

Last month, French President Nicolas Sarkozy and German Chancellor Angela Merkel met in Paris to discuss, among other things, a proposed "golden rule" to require all euro area nations to commit to balanced budgets.

The goal, they said, is to promote greater "convergence" among the policies of the core members of the EU, such as France and Germany, with those of the more troubled nations on the union's periphery.

The leaders also discussed greater coordination on corporate tax rates and the creation of a so-called financial transaction tax.

Investors have been calling for the creation of a so-called Eurobond, which would be backed by all 17 euro area nations.

Issuing a common form of debt would ease borrowing costs for the weaker members of the union. But it would also drive up rates for the stronger nations and could jeopardize their credit ratings.

Jose Manuel Barrios, president of the European Commission, recently disclosed that officials are working on different Eurobond proposals.

He said some of the options under consideration could be implemented under current laws, but others may require changes to European Union treaties.

Echoing statements made by Merkel and Sarkozy, Barroso said Eurobonds would not provide an "immediate solution for all the problems we face."

Instead, he argued, the move is part of a large effort to increase economic and political integration among euro area governments.