Markets fear the Euro economies will tank (image: Elena Schweitzer/shutterstock.com)

One of the constants until now in the unraveling of the Euro financial system has been that bond holders would accept and hold German bonds, even flee to them as they dumped other Euro-nation bonds.  That was keeping yields — and German borrowing costs – much lower than other Euro nations.

But investors threatened to blow right by that safety today when they bought less than two thirds of the German bonds up for auction.  From Reuters:

“The debt crisis is burrowing ever deeper, like a worm, and is now reaching Germany,” one of the more eurosceptic backbenchers in Angela Merkel’s center-right government, Frank Schaeffler of the junior coalition partner Free Democrats (FDP), told Reuters.

The German debt agency could not find buyers for almost half a bond sale of 6 billion euros. That pushed the cost of borrowing over 10 years for the bloc’s paymaster above those for the United States for the first time since October.

“It is a complete and utter disaster,” said Marc Ostwald, strategist at Monument Securities in London.

To be sure, German yields are still not much above 2 percent — the lowest in the Euro zone and well below the 7 percent yields threatening Italy and Spain — but an auction seen as “one of the least successful debt sales by Europe’s powerhouse economy since the launch of the single currency” is not a good sign.

It will be interesting now to see whether this affects Germany’s adamant opposition to allowing the European Central Bank backstop the Euro and Euro-nation debt.   So far, not so much:

In a forceful speech to the Bundestag, the lower house of the German parliament, Merkel issued one of her starkest warnings yet against fiddling with the bank’s strict inflation-fighting mandate. She also hit back at proposals from the European Commission on joint euro zone bond issuance, calling them “extraordinarily inappropriate.”

Shortly before she began speaking, French Finance Minister Francois Baroin told a conference in Paris that it was the ECB’s responsibility to sustain activity in the currency bloc.

“The best response to avoid contagion in countries like Spain and Italy is, from the French viewpoint, an intervention (or) the possibility of intervention or announcement of intervention by a lender of last resort, which would be the European Central Bank,” Baroin said.

More on the German bond sale from the Financial Times, and a pessimistic view on any change in German positions regarding the ECB.

In the meantime, the ECB, which insists it is legally prohibited from purchasing government bonds directly to support Euro nations, stepped up its indirect efforts by increasing its lending to European banks.  The banks hold massive quantities of Euro nation bonds that are declining in value, threatening the solvency of the banks.  According to the Financial Times, the ECB provided €247bn to banks on Tuesday, much higher than previous weeks.

There’s a massive run on the Euro system going on, and no one is stopping it.  The Euro rescue fund is too small, a jointly backed Euro bond is not available, and the IMF isn’t designed to do this.  So far, the ECB, which could solve this, has seemed to act only sporadically to provide funds to governments (indirectly) and banks. What investors are waiting for is for the ECB to announce it will do whatever it takes and not let the system fail, and convince everyone it’s serious.  That’s what a central bank acting as “lender of last resort” is supposed to do.

More from Dr. Doom, Nuriel Roubini, “Europe’s Contagion has now gone viral . . . and global” [h/t wendydavis]

Image: Elena Schweitzer/shutterstock.com