Financial markets in turmoil over new EU debt crisis fear

Stocks, the euro and government bonds tumbled suggesting investors were increasingly worried Italy will not be able to handle its debts.

Rescuing Italy and Spain – the third and fourth-largest economies in the eurozone – would simply be too expensive for the EU’s rescue funds, so their stability is synonymous with that of the 17-nation bloc.

Traders were alarmed by the fact that eurozone finance ministers remained vague in their promises of support at a meeting in Brussels on Monday and suggested they would even accept a temporary default by Greece to get a bigger private sector contribution to a second bailout.

The prospect that Greece will be allowed to default on its debts – and the lack of any detail on how that would happen or how it might impact countries like Italy – proved toxic for markets.

“The risk of a major eurozone bank collapsing cannot be ruled out and this threat would only heighten a ‘Lehman-style’ moment,” said Neil MacKinnon, a strategist at VTB Capital.

The finance ministers said they were considering broader powers for the bailout fund, such as buying up distressed bonds on the secondary market, as well as giving bailed out countries more time to repay and lower interest rates.

They did not reach a final deal on a new rescue package for Greece, however, and moved away from earlier promises that any efforts to involve banks will not trigger a default rating from agencies.

That opens the door to more drastic plans for private sector involvement and renewed concerns about a lack of political will in the richer eurozone countries to stem the crisis.

Pressure in Italian markets only eased after Finance Minister Giulio Tremonti announced plans to accelerate Italy’s austerity measures.

“I am going to Rome to close the budget,” he said as he left the ministers’ meeting early.

Italian Senate President Renato Schifani asked the upper house clear the cuts by Thursday before they go to the lower house for approval. The government had earlier said the measures would be completed only by August.

“I believe it is necessary and indispensable to give a cohesive signal abroad from our country, and it is important that we vote on the measures no later than Thursday,” he said.