Having briefly stepped down from crisis over the weekend, Europe outdid itself today, with the continent once again wavering out of control. Greece failed to produce an interim government, with its political leaders locked in talks all day. Though the country has an official government — even one that has won a vote of confidence — and a PM, that government has already promised to resign. Effectively, the country has been without real leadership for nearly a week.

Soon to be ex-PM George Papandreou and Opposition Leader Antonis Samaras — bitter rivals who were once college room-mates in the US — have had their advisers locked in talks all day over who could lead the country and under what conditions. The man widely tipped to be the next PM is not even in parliament — Lucas Papademos , a former European Central Bank official, now on a plane back from his teaching job at Harvard, and the first choice of both sides of politics.

However, Papademos is reported to be reluctant to lead a government that will only be in existence for three months, as the two sides had already agreed that the election would be held on February 19 next year. With both sides begging him to take over, and implement the October 26 agreement — which will guarantee the transfer of the €8 billion tranche that it needs to avoid default in December — Papademos is in a pretty strong position.

Plan B is that Pasok finance minister Evangelos Venizelos would become PM, with a mixed cabinet. In the current leadership vacuum, he is de facto PM in any case, representing the country at tonight’s EcoFin meeting (EU finance ministers), which had been delayed from 10 days ago. There is even a plan that Fotis Kouvelis, leader of the small Democratic Left party could be put in place as PM — as one Greek blogger remarked, this is the equivalent of French barons electing the weakest among their number as king, so he can be easily controlled.

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But for all the disquiet surrounding Greece’s failure to get its house in order, it was Italy’s seeming determination to burn the joint down that has created the most panic. Whatever can be said about Papandreou — and it has pretty much all been said over the past week — no one can deny that he has approached the issue with the utmost seriousness, and a recognition of how close the country was sailing to disaster.

Italy? Well Prime Minister Silvio Berlusconi last week delayed the release of his second album of love songs. Challenged about the €1.9 trillion debt the country is carrying, and the steadily escalating interest rates on bonds — now north of 6.6%, the established choke point being six and a half — Berlusconi responded, “look around you — the restaurants are full” — which couldn’t have been a more Italian approach to macroeconomics if he’d said it while serving gelato from a barrel organ.

There had been rumours earlier in the day that Berlusconi would resign, and the Italian sharemarket briefly rallied. When Berlusconi went out of his way to say he wouldn’t be going, the market fell again. Just to add to the absence of anything resembling governance in this process, Berlusconi’s denial was released on … Facebook. As in Greece, Berlusconi’s party is leaching MPs, and he cannot now command an automatic majority (which in any case relies on the Northern League, and other groups).

Indeed, the Left now plans to abstain on a major vote to ratify the 2010 state accounts, and other bills, until a vote of confidence is held — one that Berlo has a reasonable chance of losing, a situation unthinkable two weeks ago.

The crisis in Italy has put the Greek crisis in the shade for two reasons: the first is political instability. Though sections of the Greek public have resisted the EU/IMF/ECB troika’s imposed structures at every turn, Europe did not doubt that its leadership were competent and rational people. Berlusconi has been decadent for some time; now he appears deranged. Northern League leader Umberto Bossi is as bloody-minded as the Greek Communists; but in Italy he’s in the government, insofar as there is one.

The second problem is the size of Italy — at 12% of the EU, it’s five times the size of Greece, and two big to bail out. And since the EFSF — the stability fund that Europe is relying on — is dependent on bond issues to replenish itself, the whole continent is trapped in a death spiral. The near failure of a 10-year EFSF bond to raise  €3 billion today underlined the fact — the continent is running out of money to patch the leaks. This has been exacerbated by Germany’s continued refusal to allow the ECB to play a more direct role in bailing out or bridging for affected eurozone members.

Indeed, the more necessary it becomes to push some money towards the European south, the more it flows to the north. German bonds are at record low rates, as more and more groups park their money there — money that is, in part, the vast amounts that southern Europe is paying to service its debts.

At its core, the problem of the eurozone is not merely that different governments work under the same currency, with different fiscal, management, policies, etc — it’s one of uneven development, which would always mean that the south has to pay through the nose to borrow the north’s money. The 5-6% gap between central bank rates, and the rates at which the south must raise its finances on the market is the where the south’s development is going — beside that, issues of corruption are relatively unimportant.

The only way that genuine European union — social Europe — could have been created would have been to create large public funds at fixed rates, and tied to political reform in the receiving countries, if required. That would have been in the purported spirit of union, to make war impossible. Instead, the other function of the EU — to put political control out of the hands of actual voting public — became uppermost, and has created a reverse effect.

Instead of goodwill and a determination to put the past behind them, the crisis has pushed people back towards national pride — and eventually towards nationalism. The release of a recent report by the Demos group documents the huge rise in far-Right political groups, and the normalisation not merely of nativist politics, but of viciously xenophobic ones. As centre-right figures such as Berlusconi and Nicolas Sarkozy lose their credibility, the left gains — but so too does the Northern League, Front Nationale, and even nastier groups.

Yet in the end, it all depends on Greece. If that can be held together, Italy can be stabilised, and so on. If not, it all goes, and before Christmas. Yet for those want it to hold together, the main worry remains this — no matter what unity government the Greeks come up with, no matter what party they eventually vote in, the paradox remains. That is, while many Greek people want to stay in the euro, they will accept neither the austerity measures involved in the October 26 €130 billion deal, nor the massive privatisations, nor what would effectively be a full surrender of sovereignty. The one thing that would have resolved the will of the people is the one thing the people didn’t want — a referendum. If that isn’t a crisis of legitimacy, what would be?