The euro is in trouble, and one needn't have looked any further than the regime shakeups of 2011 for proof: both Greece and Italy lost prime ministers over the fury of the economic crisis. How did Europe's debt crisis so bad? John Makin had some answers in a December Economic Outlook, and studied where the real crisis lies:

The rise in interest rates on Italian, French, and Spanish bonds has coincided with a drop in the market value of trillions of dollars’ worth of those bonds held largely by European households and thinly capitalized European banks. As a result, the stock prices of European banks have dropped sharply, while borrowing costs in the interbank market, where banks borrow and lend overnight, have risen sharply. The rising uncertainty about the liquidity and solvency of Europe’s banks has slowed down growth in much of Europe, including Germany, which only increases the difficulty of managing growing debt burdens. Beyond that, since European governments would be called upon to underwrite losses by their banks, fears about bank solvency have further elevated government borrowing costs.

MORE: Desmond Lachman asks if the euro was a mistake to begin with

SPECIAL TOPIC: AEI's comprehensive coverage of the eurozone crisis

GETTING WORSE

Desmond Lachman testified before the House Committee on Oversight and Government Reform that "there has been a marked intensification of the European debt crisis that could have major implications for the United States economy in 2012":

The Greek economy now appears to be in freefall as indicated by a 12 percent contraction in  real GDP over the past two years and an increase in its unemployment rate to 18 ½ percent. Greek banks are now rapidly losing deposits. This makes a substantial write-down (of perhaps as much as 75 cents on the dollar) in Greece's US $450 billion sovereign debt highly probable within the next few months. Such a default would constitute the largest sovereign debt default on record and would almost certainly accentuate the contagion that is already in evidence in the European periphery.

This Lachman testimony from January basically laid the contours of the entire year’s worth of discussion on the euro crisis. This piece foreshadowed the discussions that are now taking place about enhancing the role of the ECB in supporting sovereign borrowing.

SHADOW

The Shadow Financial Regulatory Committee is a group of publicly recognized independent experts on the financial services industry—including banking, insurance and securities—who meet regularly to study and critique regulatory policies affecting this sector of the economy. This year, committee members added the latest financial regulation issues related to the continuing European crisis to the agenda.

Bridget Johnson is the managing editor of AEI.org