Did anyone really think that Italy would be able to get through this thing without needing a bailout? Just when you thought that things in Europe could get back to normal for a little while, here comes Italy. On Friday, there was a bit of a “mini-panic” as investors started dumping Italian financial assets. European officials are concerned that the sovereign debt crisis that has ravaged Greece, Ireland and Portugal will now put the Italian economy through the wringer. European Council President Herman Van Rompuy has called an emergency meeting for Monday morning. He is denying that the meeting is about Italy, but everyone knows that Italy is going to be discussed. European Central Bank President Jean-Claude Trichet and European Commission President Jose Manuel Barroso along with a host of other top officials will also be at this meeting. If it does turn out that Italy needs a bailout, it is going to change the entire game in Europe.

What is going on in Italy right now is potentially far more serious than what has been going on in Greece. Italy is the fourth largest economy in the European Union. If Italy requires a bailout, the rest of Europe might not be able to handle it.

An anonymous European Central Bank source told one German newspaper the following on Sunday….

“The existing rescue fund in Europe is not sufficient to provide a credible defensive wall for Italy”

The source also added that the current bailout fund “was never designed for that“.

Italy has already implemented austerity measures.

This was not supposed to happen.

But it is happening.

This latest crisis was precipitated by a substantial sell-off of Italian financial assets on Friday. An article posted by Bloomberg described the pounding that the two largest Italian banks took….

UniCredit SpA (UCG) and Intesa Sanpaolo SpA (ISP), Italy’s biggest banks, fell to the lowest in more than two years in Milan yesterday as contagion from Europe’s debt crisis threatened to spread to the region’s third-largest economy. UniCredit plunged 7.9 percent, the biggest decline since March 30, 2009, while Intesa dropped 4.6 percent. Both hit lows not seen since the period when markets were emerging from the crisis spawned by the collapse of Lehman Brothers Holdings Inc.

Unfortunately, this is just the continuation of a trend that has been going on for a while.

When you look at them as a group, the stocks of the five largest Italian banks have lost 27% since the beginning of 2011.

That is not a good sign.

Also, investors are starting to dump Italian government debt. Reuters says that the yield on 10 year Italian bonds is approaching the danger zone….

The spread of the Italian 10-year government bond yield over benchmark German Bunds hit euro lifetime highs around 2.45 percentage points on Friday, raising the Italian yield to 5.28 percent, close to the 5.5-5.7 percent area which some bankers think could start putting heavy pressure on Italy’s finances.

The Italian national debt is now up to about 120 percent of GDP. The Italian government would be able to manage it if interest rates were very, very low. But unfortunately they are rising fast and if they get too much higher they are going to become suffocating.

As I have written about previously, government debt becomes very painful once you take low interest rates out of the equation. For example, if Greece could borrow all of the money that it wanted to borrow at zero percent interest, it would not have a debt problem. But now the yield on 2 year Greek bonds is over 30 percent, and there is not a government on the face of the earth that can afford to pay interest that high for long.

Unfortunately for Italy, this could just be the beginning of rising interest rates. Just recently, Moody’s warned that it may be forced to downgrade Italy’s Aa2 debt rating at some point within the next couple of months.

If things continue to unravel in Italy, all of the credit agencies may downgrade Italy sooner rather than later.

The frightening thing about Italy is that a financial crisis has a way of exposing corruption, and there are very few countries that can match the kind of corruption that goes on in Italy.

As a child, I had the chance to live in Italy. I love Italy. The people are friendly, the weather is great, the architecture is amazing and the food is spectacular. I will always have great affection for Italy and I will always cheer for the Italian national team when the World Cup rolls around.

However, I also know that corruption is deeply ingrained into Italian culture. It is simply a way of life.

Just check out the prime minister of Italy. Silvio Berlusconi is the consummate Italian politician. He is greatly loved by many, but it would take days to detail all of the scandals that he has been linked to.

At this point, Berlusconi has become a parody of himself. Each new sex scandal or financial scandal just adds to his legend. Italy is one of the only nations in Europe where such a corrupt politician could have stayed in office for so long.

Not that the U.S. government is much better. Our government becomes more corrupt with each passing year.

But the point is that if a financial collapse happens in Italy and people start “turning over rocks” it could turn up all sorts of icky stuff.

So what is Europe going to do if Italy needs a bailout?

Well, they are probably going to have to fire up the printing presses because it would probably take a whole lot more euros than they have right now.

The truth is that the EU has now entered a permanent financial crisis. You have a whole bunch of nations that have accumulated unsustainable debts and that cannot print their own currencies. The financial system of the EU as it is currently constructed simply does not work.

Some believe that the sovereign debt crisis will eventually cause the breakup of the EU. Others believe that this crisis will cause it to be reformed and become much more integrated.

In any event, what just about everyone can agree on is that the financial problems of Europe are not going away any time soon. For now, EU officials are keeping all of the balls in the air, but if at some point the juggling act falters, the rest of the world better look out.

A financial crash in Europe would be felt in every nation on earth and it would be absolutely devastating. Let’s hope that we still have some more time before it happens.