Yields on 10-year Spanish bonds rose 27 basis points today to 6.80%, an all-time high. The country’s main stock exchange, the IBEX fell 1% and the Stoxx Europe 600 fell -0.2% on the news, before closing up 0.63%. The S&P 500 is up slightly more than that.

Spanish and Italian banks took most of the punishment, down -2% to nearly -6% at Italy’s Banca Monte dei Paschi di Siena SpA. The euro is down only slightly against the US dollar by just -0.02%.

But that’s not the good part. For some reason European investors continue to believe that the Eurozone is solving its problems, because share prices quickly rose again before the news of the Spanish bond auction was even cool.

The European Central Bank issued its June Finance Stability View today, identifying three “key risks” to the Eurozone:

• A potential aggravation of the debt crisis for euro area sovereigns.
• Bank profitability risk stemming from weaker economic growth and associated higher credit and asset valuation losses.
• Excessive pace of deleveraging of the banking sector due to frontloaded changes to banks’ business models.

Among the recommendations to tackle the “root causes of the crisis” are:

First, continued action is needed at the national level to both ensure fiscal discipline and accelerate structural reforms for growth and employment.
Second, an effective use of the financial backstops is needed to halt the downward spiral of self-fulfilling dynamics in the pernicious interplay between sovereign, banking and macroeconomic forces.
Third, durable changes to banking models must complement temporary Eurosystem support and provide lasting funding certainty, to accompany the strengthening of the capital base of European banks in the first half of 2012.
Fourth, continued progress is needed to eliminate political and economic uncertainty, not only to stem the forces of contagion but also to provide a more solid basis for markets to manage risk.
Fifth, measures to strengthen economic and fiscal surveillance, and to enhance governance, must be taken and not remain contingent on market-driven pressure – thereby providing credible reassurance that the crisis that has engulfed the euro area over the last few years will never be permitted to recur.

Now for the good part — a recommendation for a banking union to reach three major objectives:

First, strengthening the euro area-wide supervision of the banking sector in order to reinforce financial integration, mitigate macroeconomic imbalances and, therefore, improve the smooth conduct of the single monetary policy.
Second, breaking the link between banks and sovereigns – which significantly exacerbates the impact of any financial disturbance – also by establishing a European deposit guarantee scheme and resolution arrangements.
Third, minimising the risks for taxpayers through adequate contributions by the financial industry.

At some point the Eurozone is going to have to come up with a solution that won’t take years to implement and that will incorporate political, as well as monetary and fiscal, union. Either that or the Eurozone will break apart.

Imagine for a moment what would be happening in global markets if it were Germany and not Greece making noises about leaving the Eurozone.

Paul Ausick