Bank stress socks Europe

Europe's debt crisis is back from summer vacation with a vengeance.

Borrowing costs soared Tuesday for weaker European governments and their banks, after a series of unsettling reports about bank risks and the region's capacity to shoulder a massive debt burden.

Europe's banks under pressure

Spreads on government bonds issued by Portugal and Ireland surged above the peaks they reached in May, during the last round of market unrest. Investors were demanding 3.76 percentage points more to lend to Ireland than to Germany, and 3.51 percentage points more to lend to Portugal than Germany. Greek spreads were approaching their record highs.

The moves came after investors got bad news from almost every angle over the long Labor Day weekend in the United States.

The Bank of International Settlements reported this weekend that European banks have been loading up on bonds issued by troubled governments in Greece, Ireland, Italy, Portugal and Spain.

They did this even as private investors backed away from that debt, on the grounds that the risk of a default in one of those countries is rising as the global economic recovery slows, in part because the European Central Bank has been lending freely on the weaker nations' bonds as collateral.

Then The Wall Street Journal reported there are renewed questions about the strength of the stress tests European Union regulators carried out in July, and discrepancies in the size of various banks' exposure to troubled governments.

And in Ireland, policymakers continue to grapple with the quickest and least costly way to wind down the government's support for debt-gorged banks, which already has cost Ireland a string of credit downgrades and stands to consume a huge sum of scarce taxpayer resources.

The cost of insuring against a default on bonds issued by stressed European governments rose 9% in Spain and 7% each in Ireland, Italy and Portugal, according to CMA data.

Shares of the major European banks trading in New York, from Spain's Santander (STD) and Banco Bilboa (BBVA) to Germany's Deutsche Bank (DB) and ING (ING) of the Netherlands, tumbled 3% in early action Tuesday.

Even harder hit was Barclays (BCS) of the U.K., which dropped 5% after a surprise management change and the whiffs of a question about its own sovereign debt exposure. The bank was among those whose exposure to weaker governments was understated by the stress tests, The Wall Street Journal reported.