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Question: At what point does the sovereign debt crisis in Europe start to have a major impact on the global financial system?

The French banking system is probably where you can draw the line on the EU debt crisis becoming systemic.  The question now becomes whether or not the German politicians allow Germany to bear some of the burden to prevent sovereign defaults from bringing down the banking system.  Germany's economy has had over a 1 trillion dollar trade surplus with other Eurozone countries over the past 10yrs and their economy has benefitted enormously from the creation of the Euro.  Recent elections went against Merkel though and that will make this much more difficult for them to resolve. 

According to the WSJ, France's three largest banks - BNP, Societe Generale, and Credit Agricole - together hold almost $57 billion in Greek sovereign and private debt versus $34 billion held by the largest German banks and $14 billion at the British banks.  In addition, French banks hold over €140 billion in total Spanish debt and €400 billion in Italian debt as of the beginning of this year according to the Bank for International Settlements. 

According to Nicolas Lecaussin, the director for development at France's Institute for Economic and Fiscal Research, the French banks were mostly owned by the French government in the late 1980's and were largely insolvent in the 1990's.  He points out the French banking sector decreased by almost 50% during the decade, while those in other countries such as Britain and the U.S. grew by 39% and 50%, respectively. 

The more you read about how other countries have resolved banking crisis in the past the more you realize how effective TARP was at preventing a collapse in the banking system and economy.  As appalling as it was that these big institutions were bailed out the end result was a net profit to the government and avoiding the nationalization of our biggest banks.  This would have wiped out equity holders (pensions, endowments, retirement plans, etc.) and even worse had bureaucrats in charge of our banking system. 

One only needs to look at the history of nationalizing banks in Europe and the UK to realize how bad the alternative outcome could have been.  It wasn't perfect - autos and AIG did not hold bank charters and were only included b/c politicians actually used to compromise to get things done - but I think we were very fortunate to have someone with an understanding of the financial system like Hank Paulson. 

There are rumors that the Chinese will step in with a commitment to purchase more European sovereign debt but nothing has been confirmed yet.  Approximately 25% of China's reserves are in Euro denominated debt so there is definitely room for them to increase their position.  The Chinese sell more goods and services to the Europeans than they do the U.S. so it is definitely in their best interest to ensure Europe's economy does not suffer a banking crisis and economic collapse. 

The politics surrounding the EU are very complex and seem to be changing by the day.  We expect the capital markets to remain volatile until the relevant parties involved, including the EU members, ECB, IMF, and central banks around the world come out with a coordinated resolution the market believes.