Italy & Spain: Too Big to Save

The European debt crisis has finally revealed itself to be about something much bigger than Greece... or Ireland or Portugal.

And the crisis is poised to become epically expensive.

Italy and Spain are the third- and fourth-largest economies in the eurozone, and they are now at the center of the crisis. Bailing them out would far exceed the European Union's rescue funds.

Paradoxically, both nations are too big to fail, yet too big to save. If either nation were to default, the impacts would be absolutely historic and would be felt worldwide.

Italy's debt equals 120 percent of its economic output and is the second biggest in the eurozone, after Greece.

That's the reason for concern.

Spain’s public debt equalled 63.6% of the country’s GDP at the end of the first quarter.

The European Stability and Growth Pact — an accord agreed to by all Eurozone member states — imposes a 60% limit on debt. But that hasn't stopped either nation from plowing itself further into indebtedness.

“Spain and Italy are nearly five times the size of Greece, Portugal and Ireland and carry nearly four times the volume of debt,” says Michael Darda, economist at MKM Partners in Stamford, Connecticut.

In other words, Italy and Spain are the real reasons to worry. Either nation has the potential to blow up the Eurozone and the euro itself.

This has started to worry investors and jack up interest rates on Italian and Spanish debt.

The yield – or interest rate – on Spanish 10-year bonds has hit 6.2 percent. Meanwhile, Italian 10-year bond yields recently eclipsed 6 percent for the first time since 1997. That's a clear warning signal.

According to analysts, the 6 percent rate will present serious challenges for Italy, but 7 percent bond yields would be unsustainable. Greece, Ireland and Portugal all sought international assistance after their 10-year yields rose past 7 percent.

It seems that Italy is now uncomfortably close to the danger zone.

Italy has more than 500 billion euros of bonds maturing in the next three years — about twice the 256 billion euros extended to Greece, Ireland and Portugal in their three-year aid programs. This provides some scale to the magnitude of Italy's debt burden.

Italy’s economy, which has been sluggish for the better part of a decade, is not growing fast enough to cover its massive debt load.

The International Monetary Fund expects Italy's economy to grow 1.3 percent in 2012, a significant increase from this year. Growth was 0.1 percent in the first quarter, a fraction of the 0.8 percent for the euro region.

The problem for all countries with high debt loads is that even as they impose strict austerity measures to shrink and eventually balance their budget deficits, they still have to contend with unyielding and expensive debt costs.

Both Moody's and S&P have issued warnings about Italy's ability to trim its debt. An economy of that size, facing problems of this magnitude, is nothing short of alarming.

Despite all of that, Spain is thought to be the bigger risk at the moment.

If a full-blown debt crisis breaks out in Italy or Spain, the euro union would face disintegration — a cataclysm far beyond anything it has grappled with to date.

Such a crisis would also create a domino effect of imploding banks.

Barclays Capital says European banks have total claims and potential exposures of 998.7 billion euros to Italy, more than six times the 162.4 billion euro exposure they have to Greece.

Think about that; Greece already has the whole world spooked, yet its debts are relatively tiny.

Italy, however, is a big fish. And so is Spain.

European banks have 774 billion euros of exposure to Spain and 534 billion euros of exposure to Ireland.

However, the problem is not just Europe's alone.

U.S. banks are more exposed to Italy than to any other euro zone country, to the tune of 269 billion euros, according to Barclays. American banks’ next biggest exposure is to Spain, with total claims estimated at 179 billion euros.

So, the problems in Italy and Spain will have far reaching consequences and will send shock waves through the global economy.

This is no longer a debt crisis involving lesser countries with small economies; the big fish are now in the fryer.