WHEN the credit crunch exploded onto the world`s financial markets last summer, politicians and bankers in the eurozone found it hard to avoid feeling at least a little smug.

Apart from a couple of high-profile early casualties, most continental financial institutions appeared to have avoided the racy business practices that had endangered their Anglo-Saxon rivals; and while Ireland and Spain were in the grip of a painful housing crash, most other eurozone economies seemed to have got off relatively lightly.

But the longer the crisis has gone on, the more the economic outlook for Europe has darkened. And over the past fortnight, as US Treasury Secretary Hank Paulson has battled to win legislators` approval for his bank rescue plan, any remaining confidence in the resilience of the European financial sector has drained away. A clutch of heavy-hitting European economists, including Willem Buiter, a former member of the monetary policy committee, and Richard Baldwin, director of the Centre for Economic Policy Research, sent an open letter to leaders last week, exhorting them to take urgent action to underpin the banking sector. `If the turmoil produces credit market paralysis, jobs and businesses will be destroyed on a massive scale,` they warned, evoking the spectre of the Great Depression of the Thirties.

Already, the Irish economy is technically in recession, having suffered two successive quarters of negative growth, after the rampant property boom that has seen swish apartment blocks rising up on every empty space on the outskirts of Dublin turned to bust. Spain, too, looks set for a sharp downturn as its property bubble bursts.

And while Germany, with its powerful manufacturing sector and prudent consumers, initially looked likely to escape the worst effects of the credit crunch, recent business surveys have shown optimism plummeting in the world`s biggest exporter. A recent poll by the French newspaper Le Figaro showed that 80 per cent of people believe the country is on the brink of a `grave economic crisis`.

The feeling that a storm brewed on the other side of the Atlantic has swept in to engulf Europe has sparked public outrage and strengthened the elbow of those politicians who have argued for some time that they would like to see, as Winston Churchill put it, `finance less proud and industry more content`.

French President Nicolas Sarkozy, who on Saturday chaired crisis talks in Paris, has made it quite clear where he lays the blame. In a blistering speech to the UN in September, he turned on the deregulated, laissez-faire model which he blames for allowing the credit bubble to run dangerously out of control.

`A certain idea of globalisation is biting the dust with the end of a financial capitalism which had imposed its rationale on the whole economy and contributed to corrupting it,` he said. `The idea of the all-powerful market which wasn`t to be impeded by rules or political intervention was mad.` Politicians seeking to make the argument for further deregulation — as Gordon Brown did repeatedly in Brussels during his decade as Chancellor — are likely to get short shrift in the years ahead.

First, though, politicians must deal with the immediate financial crisis and its broader economic fallout. The European Central Bank (ECB) has acted decisively throughout to pump huge sums into the financial markets, helping banks to avoid the short-term liquidity problems that were initially the main focus of concern.

But over recent weeks, investors` worries have switched to the more threatening issue of whether some banks will face a shortfall of capital and how hard the struggles of the financial sector could hit the rest of the economy.

Jean-Claude Trichet, president of the European Central Bank, left eurozone interest rates on hold at 4.25 per cent at its regular meeting on Thursday; but he stressed that there were `exceptionally high levels of uncertainty` in financial markets and added that the risks for future growth in the 15-member zone were `on the down side`.

Jacques Cailloux, European economist at Royal Bank of Scotland, says Trichet`s comments suggest mounting fears at the ECB`s Frankfurt headquarters about the health of the economy. `The ECB has signalled today that it is prepared to cut rates any time, alone or in a co-ordinated fashion,` he says.

There is also rising disquiet about the cost to Europe`s taxpayers of propping up one financial domino after another. So far, analysts say the bail-outs will not put too much strain on public finances.

— The Guardian, London