Wonder why the Greek 2 Year bond just plunged, sending its yield to a laughable all time high 39.09% (a 312 bps move today alone)? Wonder no more. According to the ECB’s Ewald Novotny the central bank has folded to German demands, and will now allow a “temporary” Greek default. Of course, what happens next will be a complete freeze in capital markets (see the chart below which shows borrowings on the ECB’s Main Refinancing Operation while itis still available) but who cares: the central planners think they have it all under control.

From Bloomberg:

European Central Bank council member Ewald Nowotny suggested the bank may compromise and allow a temporary Greek default as officials scramble to fix a sovereign debt crisis that’s spreading to Italy and Spain before a leaders’ summit in two days.

As Spanish financing costs surged at a 4.45 billion euro ($6.31 billion) treasury bill auction today, policy makers are trying to ease a split that’s pushed interest rates on Spanish and Italian 10-year debt above 6 percent for the first time since the euro debuted 12 years ago. The ECB has until now argued that any Greek default could spark a new financial crisis, derailing a German push to make investors help foot the bill for a second bailout of the country.

“This has to be studied in a very serious way,” he told CNBC in an interview broadcast today. “There are some proposals that deal with a very short-lived selective default situation that will not have major negative consequences.”

Ironically, the ECB is correct about the consequences, which explains its unwillingness to push forward with this plan. However, Germany’s realization that none of its banks are pregnant with Greek debt is waht has allowed the follow through. The problem however, as everyone who dabbles in these things, is known as unintended consequences. And despite what you may have read in various books by assorted namedropping anchormen, the administration was 100% confident it could contain Lehman when it failed as well. Oh well, it was bound to happen sooner or later.

We still have a sinking feeling that a “temporary” Greek default may be announced as soon as 48 hours from now when the EU leader meeting concludes on Thursday.

One thing is certain: European banks arent taking any chances, with borrowings under the ECB’s weekly MRO just surging to a 2011 high of €197 billion as everyone seeks to shore up capital in advance of what could be a complete liquidity freeze later this week.

This post originally appeared at Zero Hedge and is reproduced here with permission.