When banks in the eurozone are shunned by the market, they can turn to the European Central Bank. But that raises another issue.

The European Central Bank cuts off support

Eurozone banks can borrow as much as they want from the central bank at zero interest, but there is a catch. They have to put up collateral. One of the most common forms of collateral is, wouldn’t you know it, government bonds.

If those bonds are rated junk by all four ratings agencies, the European Central Bank no longer accepts them. This happened to banks in Greece when Greek government bonds fell to junk status, contributing to severe economic hardship.

The banks can stake other collateral, such as bonds from more solvent countries or corporate debt. But experience shows that troubled banks are usually short of other assets. They can still borrow money from the central bank, but at significantly higher interest rates, putting them at a competitive disadvantage.

The European Central Bank has a separate program that would allow it to buy Italian bonds on the open market, helping to hold down the country’s borrowing costs. But Italy would be eligible only if it agreed to conditions that would certainly include spending limits, something the populist government is unlikely to accept.

Italy suffers a credit crunch and slips into recession

Bank woes become problems in everyday life because businesses and consumers can no longer get credit. They spend less, and growth slumps. In Italy’s case, the overstretched government would not be able to pay for bank rescues. (One of the reasons Italy is in so much debt in the first place is that it has already spent huge sums rescuing its banks.)

When people spend and earn less, they pay less in taxes. Government revenue drops, Rome’s ability to make debt payments suffers, and a vicious cycle begins that is difficult to stop at the nation’s borders.