The cost of insuring Spanish and Portuguese government debt against default soared on Tuesday, while stock markets in Madrid, Lisbon and Athens posted sharp losses, as fears that the European debt crisis is spreading returned in full force.

Investors are worried that Greek debt may still need to be restructured even after the European Union and the International Monetary Fund came to the rescue with a 110 billion-euro bailout package.

It is a problem of confidence, not speculators. Investors have lost  confidence in Europe…

Source Bloomberg, Financial Institution´s risk

Greek bonds plunged on  Monday amid growing worries among investors that the country will need to restructure its debts in spite of a proposed €45bn ($60bn) assistance package from the international community.

The yield on two-year Greek government bonds, which has an inverse relationship with price, jumped 3 percentage points  to close at 13.52 %

This is the highest yield on short-dated government debt in the world !!!  according to US bank, Brown Brothers Harriman.

Investors treated  Greek bonds  pricing in a government default as two-year bond yields were trading more than 12 percentage points higher than German Bunds.

Meanwhile, the fallout is now spreading to other countries like Spain, Portugal, and Italy as debt spreads are increasing as well.  Signs of contagion are apparent as peripheral countries witnessed their bond yields and CDS spreads widen with the deterioration of Greece.

What is troubling is that Spain and Portugal comprise a large portion of CDS outstanding.  According to the Depository Trust and Clearing Corporation (DTCC), sovereigns including Spain (15.2%), Greece (8.8%), and Portugal (9.6%) are among the largest reference entities for CDS outstanding.

According to Morgan Stanley, the risk for contagion is high as the countries are linked.  32 percent of Spain’s debt is owned by German banks while 25 percent is owned by French banks.  In addition, 51 percent of Portugal’s debt is owned by Spanish banks. Therefore, problems in Portugal debt could easily spillover to the strongest economies.