The Eurocrats Lose Control

Markets have been getting crushed today. A spike in Italian bond yields sparked a steep selloff in Europe that continued as US markets opened.

The selloff signals that the European crisis is reaching a dangerous endgame, for which nobody seems to have the answer. First Ireland, then Greece, and now Portugal, Spain, and Italy (one of Europe's largest economies). With rates on Italian debt spiking over 7% during a time of near-zero worldwide rates, a lethal debt spiral has commenced, since Italy must pay more to service its debt.

Think that doesn't matter? According to Bergen Capital, more than $200 billion of Italian debt comes due in the next two years.

This may be ending a strange period of headline-driven trading in which stock operators have bought and sold based on the Italian prime minister's every last move -- how he combed his hair, how he reorganized his network of floozies, whether he bought a new Ferrari. The smart money was (and is) watching Italian bonds. Sovereign debt is the atomic bomb. It blew up MF Global, and there are plenty of global banks holding too much leveraged debt to support a vicious rise in yields (and a collapse in bond prices).

So the crisis is climaxing, and, as many crises do, it can spiral out of control faster than people imagine. Here's what I see as the major problems:

• Despite all the noise about the European Financial Stability Facility (EFSF) and the latest "rescue," the details have not been worked out. In fact, they haven't gotten the money pledged to fund the bailout. As I noted a couple of weeks ago, you can't solve debt with more debt. (See: Europe's Hall of Mirrors.)

• There is chatter that the European Central Bank (ECB) is planning to step in and help out, but there is a big problem with that: The Maastricht Treaty prevents the ECB from bailing out individual nations or directly financing their spending.

• Do you know Italy was supposed to contribute 19% to the EFSF? Spain is supposed to contribute 12%. That means two of Europe's largest countries are supposed to contribute 31% of their own bailout. But, wait, you mean bailers are also the bailees?

• There is disagreement among the major European countries on how to deal with the problem. German banking leaders are leery of a monetary solution (a.k.a. the US "print money" solution). And Germany won't back the euro with gold. What does that tell you about German confidence in the euro? Tensions even in the core "strong" part of the euro area remain high.

• European banks are overleveraged. Many have leverage ratios (assets/equity) of more than 20 to 1. (Some say 30 to 1.) They always hold a lot of sovereign debt. The more sovereign debt sinks (as yields rise), the more the banks get in big trouble.

• This crisis is unfolding in exactly in same sequence as the Bear Stearns financial crisis in 2008. Bear Stearns failed. There was regulatory and rescue action. Then the markets rallied, figuring it was a one-off. So far, the markets think that Greece and MF Global are isolated incidents. They don't see the crises as connected.

• Nobody's paying attention to China. Everybody expects it to help with a bailout, yet it has said no. Why? It has its own problems. The yield curve has inverted. For those who don't follow it, an inverted yield curve -- in which shorter-term rates are more expensive than longer-term rates -- is one of the most reliable indicators of recession.

Last night Barclays released a remarkable report on Italy saying the "game is over" -- as the firm's share price rapidly declines. (Barclays, of course, holds plenty of European debt).

What I really don't like about markets are the charts -- eerily similar to 2008. The rally we just had took the S&P 500 back up to the 200-day moving average, and it's failing. That's exactly what happened after Bear Stearns in 2008. As we know, that was just the beginning of a long decline.

Through all of this, with markets down 3% in morning trading, we are facing a potential crash. Yet the European leaders have been remarkably slow and complacent in dealing with all of this. That's because their options are limited. Europe is held together with duct tape for now, and the IMF and China have indicated they're in no rush to come to the rescue. The United States has its own problems.

Watch out below. This could get ugly in a hurry.

(Disclosure: Lots of cash, short some stocks, long some stocks, short copper, long gold.)