The stock market is at it again. After bouncing back last week, there was a huge sell-off Thursday.

The Dow Jones industrial average lost 419 points — more than 3.5 percent on the day — and once again, Europe’s debt crisis was a big factor. It’s affecting European banks which, in turn, affect the U.S. financial sector.

European bank stocks had lost as much as 14 percent of their value by the time the U.S. markets opened.

And so ensued the U.S. sell-off. Shortly after the open, the Dow was down more than 500 points — and Bank of America and Citigroup were among the biggest losers.

U.S. banks have lots on the line: Citigroup has said it has $22 billion invested in the financially troubled European countries of Greece, Ireland, Portugal, Italy and Spain. Additionally, JPMorgan Chase has $17 billion invested and Bank of America has $15 billion.

However, those numbers don’t include the much larger indirect stake U.S. banks have in Europe.

U.S. financial institutions lend lots of money to European banks. U.S. banks are also traders in credit default swaps, which function like insurance, so banks may have to pay out in the event of a default.

Canary In The Coal Mine

The market is anxious in part because it’s impossible to pin down how much total exposure banks have.

Still, there are those who believe the banks will simply not be allowed to fail.

“I don’t sit here worrying about the collapse of the European banking system,” says Ernest Patrikis, former vice president and general counsel of the Federal Reserve Bank of New York, which oversees many of the U.S. branches of European banks.

Patrikis says the New York Fed and other regulators are no doubt assessing where the banks’ vulnerabilities are. He calls it prophylactic planning.

“To date in the world, no major country has ever let a major bank fail in that country — at least fail overnight or quickly or something,” he says. “I think the vulnerabilities go well beyond the banking system.”

Those who fret solely about the health of the banks miss the larger point, which is what happens to banks can hurt the overall economy.

“You have to remember that the banking system is the canary in the coal mine,” says Nancy Bush, a banking analyst and contributing editor to SNL Financial.

“Generally, the tremors are felt first in the banking system, as they were in 2008,” she says. “And then because of the banks’ inability to provide credit, those problems are transmitted into the larger economy.”

Another Recession?

And that is how fear and concern about default threatens to undermine an already weak economy.

And Thursday brought more bad news on that front: Morgan Stanley cut its expectations for growth in Europe through next year.

In the U.S., the Philadelphia Federal Reserve said factory activity in its region plummeted; home sales fell last month; and claims for unemployment insurance rose last week.

Meanwhile, the price of gold surged and oil prices fell on fears of another recession.

None of that bodes well for trade or consumer demand, both of which drive growth in Europe and the U.S.

Bush says that flies in the face of all the analysts, including herself, who had projected stronger growth for the U.S. economy later this year.

“Things were going to get better,” she says. “Well, now it looks like things may not get better.”

During the last recession, the U.S. was able to work its way out. The Federal Reserve lowered interest rates to near zero, and Congress delivered a huge stimulus package.

Now, interest rates are as low as they can go, and there’s no support for another spending spree. So it’s not clear how the U.S. could pull itself out of another downturn.