Crisis enters a new phase

"The smell of fear is in the air," said Tom di Galoma of Guggenheim Partners. A wave of risk-aversion swept markets early this week, sending the FTSE below 5,000 for the first time since October. Asian stocks hit a ten-month low. Commodities also tanked, with oil at a three-month low, while gold soared.

The three-month interbank dollar lending rate (Libor) reached a ten-month high. The VIX index, a key gauge of risk-aversion, has risen almost threefold since mid-April. While stocks recovered on Wednesday, the mood remained nervous and the euro stayed close to a four-year low against the dollar.

What the commentators said

This week's turbulence looked "eerily like a repeat" of the time after Bear Stearns collapsed in early 2008 the mounting jitters in the run-up to Lehman's implosion, said Allister Heath in City AM. Investors were panicked by every piece of bad news and there have been plenty of worrying developments. The Korean peninsula may be sliding towards conflict. North Korea has ordered its military to prepare for war after Seoul accused it of torpedoing a South Korean ship. Another element of political risk is uncertainty over US banking regulation and another "useless and counterproductive" attempt by Germany to clamp down on speculators.

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But the main problem is the eurozone mess, and European banks' exposure to it, as David Wighton pointed out in The Times. The choice is simple and "dismal". Either the peripheral countries get to grips with their debt piles, in which case austerity measures "look likely to tip Europe back into recession". Or they don't, which raises the prospect of "a full-blown euro bust up" and defaults or debt restructurings that could bring Europe's banks to their knees.

Not only do banks have huge exposure to peripheral debt, but they never underwent stress tests like their British and US counterparts, says Hugo Dixon on Breakingviews. So nobody really knows what state their balance sheets are in. Insolvent or badly damaged banks can send shockwaves though the financial system, as we saw when Lehmans collapsed. It's no wonder global banks are becoming increasingly wary about lending to each other. As their funding costs rise, credit will get tighter, damaging growth prospects.

But it's not just the banks' eurozone exposure that worries the markets, said Jeremy Warner on Telegraph.co.uk. It's the threat of a double-dip recession, which would cause "a new round" of bad debts. "Liquidity is being withdrawn in anticipation." The sovereign-debt crisis is threatening to "reinfect the banking sector". Even more worrying, "few if any can afford another round of bank bail-outs".