Italy, on the other hand, is more than capable of causing problems for Italy.
Part of the reason put forward why we can not allow a Greek default is that contagion would rapidly cause problems to spread to the other peripheral countries and then strike Spain and Italy. I think the evidence from the CDS market over the past 3 months does not support this view.
At the end of June, Portugal and Ireland were trading at 753 (basis points) and 744 respectively, while Italy, Spain and France were at 172, 261 and 81.
Since then the Greek position has moved materially closer to default as the deficit goals have not been met. Therefore, one would expect Portugal and Ireland to widen the most, followed by Spain, then Italy, then France.
What actually happend is that, yes, Portugal increased 344 to 1097, but Ireland decreased to 705. Just think about that. In a 3 month period when equity markets dropped roughly 25% and bond spreads widened everywhere, one of the countries apparently most at risk from contagion and loss of investor confidence from a Greek default saw its CDS spread drop.
The movement for Italy followed the contagion hypothesis and its CDS rose from 172 to 426, a move of 254, but Spain increased by only 95 to 356, while France rose by nearly the same amount, 85, to 166. Why did Spain rise by so little with respect to France when it is Spain that is apparently at risk of contagion. Purchases by the ECB? Maybe, but then why did Italy rise so much. The evidence does not support the hypothesis of the market being worried about problems caused by a Greek default being the major factor in where Spanish and Italian government debt is trading.
What the evidence does seem to say is the actions of the Spanish and Italian governments are the most important factor. Spain has put forward a positively received, fiscal plan, while Italy has not.
My conclusion is that contagion is not a problem for Ireland, Portugal, Spain and Italy, which should not be a surprise as they hold very small amounts of Greek debt. The message to the government from this is to ignore the noise around Greece and put together a coherent plan to encourage growth and curb the deficit. The market will reward you.