Is Berlusconi right? Hedge funds and Two Italian Jobs
Nice of the Italian Prime minister to take a break from running his own financial empire to attend to the crisis enveloping Italy.
Italian bond yields are on a handcart heading straight towards the hell marked “7%”. This after the passing of austerity plan in the Italian parliament and the uber-bailout announced at last month’s EU heads of state meeting. (Italian Job No1: How can Italy possibly pay out bilateral loans of about €5bn to Greece (agreed in May 2010) at the new discount 3.5% interest rate, when it would have to raise that money at over 6%?)
The Italian Prime minister said Italy was “solid” and that markets were “incorrect”. He even crowed that his experience of running three stock market-listed companies meant he understood the markets. The easy temptation might be to dismiss this. I think he might be right.
Much of the argument about Italy is entirely circular. Watch the so-called experts carefully. They’ll say stuff like “markets are worried”, “markets think”, “markets are unconvinced”. This is clearly guff. Markets are not sentient beings. Italy’s bond yields are being forced up because serious market players are taking positions in thin August markets. They are piling into Italian Credit Default Swap markets, that have the eventual effect of ratcheting up Italian borrowing costs. That then begets a crisis that is self-fulfilling.
All clever speculations, however, are rooted in truths. Italy’s deficit at 4.6% is large but not as big as eurozone peers, and half Britain’s. It’s starting national debt at 119% of GDP is clearly terrible. Italian politics is fractious. And Signor Berlusconi does not look like a man who is concentrated on this crisis with every fibre of his body. But still the majority of Italy’s debt is owned domestically. And Italy’s average debt matuity is over 7 years, according to Moody’s.
The real bet being made here though has been opened up by the famed “PSI” or private sector involvement unleashed “voluntarily” upon Greece’s bankers, that will see bondholders lose 20% of their money. At the time of this deal you can see why Eurozone leaders were adamant that this would not spread to other countries. However this clutch of mainly US hedge funds clearly thinks that it is inevitable (Italian Job Number 2). More than that, by injecting that credible doubt into the worried minds of Italian pension funds and banks that hold Italian government debt, then just maybe their bet might come off.
The bigger picture here: that the speculators piling in against Italy do not believe that Germany will want or can afford to write a cheque for an economy as big as Italy. It is a test of wills. The end game could well require that the eurozone bailout facility be extended to a trillion or two euros. As Divyang Shah of IFR markets has calculated, given Italian Job No 1 above, this takes the burden of funding required form Germany to 43% and France 32%.
“Given the total of 75% it would be hard to argue that we don’t already have a transfer union for the Eurozone,” writes Shah.
The problem is that even extending its powers to buy Italian debts, as agreed in July, will require the approval of Eurozone parliaments. And nothing gets German politics more riled than the words “transfer union”.
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