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Investors Punish Italy ETF

Stocks in this article: EWI EWP EWK

NEW YORK ( TheStreet) -- Italy has become the new focus of euro skeptics as pessimism over Europe grows.

Many investors were focused on the Spanish housing and banking situation, expecting it would be the source of financial turbulence for the currency union, when Greece stepped into the picture and seized global attention.

Over the course of a month, the euro fell from $1.45 to $1.35, but the decline has slowed recently. Greece has until March 16 to come up with a plan to cut its deficit, and this has calmed the markets for the moment.

However, the pause in activity didn't turn attention back to Spain; instead, investors have taken a deeper look at Italy. At the national level, and similar to Greece, Italy used currency swaps to help it enter into the common currency. Although Italy is not in the same fiscal situation as Greece, the parallel is still a disconcerting one.

Italy's municipal governments also used derivatives. Earlier this month, the Italian government seized assets of Bank of America (BAC) and Dexia SA as part of an investigation into derivatives contracts within one municipality.

All told, 519 municipalities have used derivatives contracts that have resulted in nearly a billion euros in losses. The amount isn't the concern here, but rather the widespread use of derivatives, which for obvious reasons carry a negative connotation with investors.

On top of these concerns, this weekend, Columbia economics professor Robert Mundell, widely credited as laying the intellectual groundwork for the creation of a common currency, said Italy is the greatest threat to the euro. Italy has about 25% of eurozone debt, several times larger than Greece's share, and a crisis there would be several times larger than the crisis in Greece.

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