The European financial crisis is consuming all available attention in Europe and quite a bit beyond Europe as well. Its causes are many, but can be summed up as a massive overcrediting of states, banks and corporations that now must be dealt with. STRATFOR has outlined the path we see the Europeans following in order to find a way out of the crisis. Key to this effort is the eurozone bailout mechanism — the European Financial Stability Facility (EFSF) — which upon full ratification will have the legal powers to address many of Europe's financial woes. The only real obstacle remaining to the expansion of the EFSF's powers is the approval of Slovakia, and after another drama-filled week we expect Bratislava to give its assent. It was widely believed that after Slovakia approved the EFSF reforms, things in Europe would quiet down somewhat. Though the EFSF would still not be large enough to handle the full scope of problems, the facility's upgrading would have bought the Europeans some time to figure out how to expand the EFSF to a larger, more capable force. However, two developments on Tuesday raise the possibility — even likelihood — that Europe's financial woes are about to worsen severely. The first development is a decision by Moody's Investor Service credit ratings agency to downgrade Italian government debt by three notches to A2 with a negative outlook. The cost to Italy of borrowing from international markets is about to go up dramatically. It's hard to recall another time a state that wasn't on the final verge of default or receivership faced a triple downgrade. Two developments on Tuesday raise the possibility — even likelihood — that Europe's financial woes are about to worsen severely. Not that Italy isn't deserving. The foibles of Prime Minister Silvio Berlusconi long ago degenerated from entertaining to debilitating. He's gutted his government and coalition of competent individuals for fear they may seek to displace him. The only remaining technocrat in the government's upper echelons, Economy and Finance Minister Giulio Tremonti, is now regularly used as Berlusconi's scapegoat for the government's meek efforts at budgetary control. The southern two-thirds of Italy has always been a massive drain on state coffers, and at 120 percent of gross domestic product, the state debt is the highest in the eurozone outside of Greece. The second development is the sudden deterioration of Dexia, a major Franco-Belgian bank, which has cast the other side of the European debt crisis into stark relief. The overcrediting of Europe was not limited to governments. Between the sudden cheapening and glut of credit in the 2000s and a massive consumption boom, most of Europe's banks are massively overextended and undercapitalized. Imagine the U.S. subprime disaster, but not limited to any particular region or subsector. That's the scale of the problem Europe's banking sector faces. After weeks of formal denials out of governments and the EU Commission, European Commissioner for Internal Market and Services Michel Barnier finally broke with the party line today describing the rapidly worsening status of Europe's banks as "a fact of life." But even among European banks, Dexia stands out as one of the worst. Dexia holds roughly 520 billion euros in assets but has only 8.8 billion euros in equity, making for a leverage ratio of approximately 60:1. A healthy ratio would be 10:1. For comparison, when the American firm Lehman Brothers went bust in 2008 its ratio was 31:1. This isn't only a bank that has failed, it has now failed twice. It crashed the first time back in 2008, when a 6.4 billion-euro bailout allowed it to linger on to the present day (what's left of that 6.4 billion euro is included in the 8.8 billion figure of available equity). As a consequence of that bailout, Dexia became majority state-owned (23.3 percent by various French government interests, and 30.5 percent Belgian government interests). Belgian and French authorities now appear set to break Dexia apart, loading its bad assets into a separate facility which will likely leech off of taxpayer money until they can be formally disposed off. The problem is that there isn't much Belgian taxpayer money to be brought to bear. After all, Dexia has long served as a primary supplier of capital to Belgium's national and regional governments. Very conservatively, Dexia is going to be absorbing 10 billion euros in government resources, and that's assuming there are no problems with the 20 billion euros in Greek, Portuguese and Italian government bonds that the bank holds. Belgium, like Italy, is getting deeper in debt and finding it increasingly difficult to tap international capital markets — particularly in the sort of big chunks that would be required to wind down Dexia. And while Italy's governing leadership can be charitably described as eccentric, Belgium's is quitting: the country has been without a government for 480 days and in September, acting Prime Minister Yves Leterme announced he'd soon be leaving his job. The Europeans now face three challenges. First, while the EFSF is nearly ready to enter into reinvigorated force, it is not nearly large enough to handle an Italian bailout. That would require — at minimum — 700 billion euros. Second, while the new and improved EFSF is designed to handle bank bailouts as well, and it probably can handle Dexia, the bank is the proverbial canary in a coal mine. There are many more banks like Dexia, some several times as large, and bailing them out will cost vastly more than the EFSF's functional ceiling of 440 billion euros would cover. Third, as the Dexia-Belgium crossover vividly underscores, Europe's sovereign debt and banking crises are formally interlinked: a broke government cannot recapitalize damaged banks while damaged banks cannot help finance a broke government. Should one side stumble, the result is a near-immediate cascade of failures on the other. And all of this assumes that Greece, which has heretofore served as the crisis' epicenter, doesn't throw any more unexpected problems Europe's way.