While we were celebrating a good night fending off the hounds of conservatism, Europe reached the point of no return. Italian bonds surged overnight. They got as high as 7.48%, before going back down at press time to 7.25%. Greece, Portugal and Ireland all sought bailouts once their bond yields hit 7%. At this rate, Italy could lose the ability to borrow. And Europe doesn’t yet have the financial arrangements in place to absorb an Italian bailout, nor do they have the will – some would say the mechanism – to print it.
The cost of using Italian bonds to raise funds rose on Wednesday after clearing house LCH.Clearnet increased the margin on debt from the euro zone’s third largest country at a time when its bonds yields are close to levels deemed unsustainable.
Banks use government bonds as collateral to access cash in the repurchase (repo) market, in which a handful of clearing houses play a vital role, assuming lending risks to provide institutions with the cash.
Clearing houses, such as LCH.Clearnet, collect cash in the form of margin on individual trades, which they hold centrally to refund members left out of pocket in the event of a default.
When LCH.Clearnet Ltd took similar action on Portuguese and Irish debt as bond yields soared, it added to selling pressure on the paper. Both countries were later forced to seek bailouts.
This becomes a vicious cycle. Creditors want higher yields on debt as the margin goes up, and that drives up the margin. This will affect margin calls starting tomorrow, so that’s the real day to watch Italian bonds.
The backdrop to all this is the sudden resignation of Silvio Berlusconi, in his second term as Prime Minister. After an emperor-has-no-clothes vote on a routine budget bill, which passed without a majority, Berlusconi offered to resign after the Italian Parliament passed his austerity bill. Since the bills could take weeks if not months, it’s correct to see this as possibly buying time to rebuild his coalition or to embark on an election strategy for the vote that will follow. Berlusconi has been declared dead a number of times, but when you own practically the entire media and have more money than any other Italian, you tend to have nine political lives or more.
What’s not in his favor is that the European leadership, muscling in on Italy’s national sovereignty, wants those austerity measures passed as soon as possible, as they watch the bond yields rise. The muscle is coming in:
A European Commission delegation is expected to arrive in Rome on Wednesday to monitor Italy’s compliance with its debt-reduction targets and the long-promised measures to lift the economy out of a feared double-dip recession. David Lipton, deputy head of the International Monetary Fund, is to follow next week.
Olli Rehn, the European Union’s economic and monetary commissioner, on Tuesday night expressed alarm over the widening yield gap between Italian and German 10-year bonds, which jumped back above 490 basis points – close to euro-era highs reached earlier in the day – after a key parliamentary vote demonstrated that Mr Berlusconi’s government had lost its absolute majority.
“The economic and financial situation of Italy is very worrying,” Mr Rehn said in Brussels.
One of the key austerity measures, an increase in the retirement age, is virulently opposed by Berlusconi’s main coalition partner, the far-right, nationalist Northern League. Umberto Bossi, head of the Northern League, is probably the first name on the European Commission and the IMF’s list. But the quicker Berlusconi gets out, and a broad coalition government can take over, the better. Like in Greece, that’s what it will take to deliver their austerity regime.
But the fact that the bond yield surged even after Berlusconi, whose erratic leadership was seen as a major factor in Italy’s crisis, offered to resign, doesn’t bode well for Europe. And the Greek situation continues to be a mess. Lucas Papademos, a non-politician, has agreed to become Prime Minister, but squabbling among the parties has delayed the transition. EU leaders wanted a written pledge from the opposition New Democracy Party that they would abide by the terms of the new bailout/austerity regime. Antonis Samaras, the leader of the party, balked. New Democracy had already written a communique pledging to reverse the austerity measures once they got into power. The politicians are angling for the next elections:
In one of the stranger twists, Mr. Papademos is apparently insisting that the current finance minister, Mr. Venizelos, who will most likely run for prime minister in the next elections, step down. But Mr. Samaras, who would like to run against him, is demanding that he stay, some local news outlets have reported.
More from the Athens Times.
All of this political gamesmanship, and the increasingly brutal demands from the European leadership, is in service to saving the euro, which is really not worth saving. The euro, and more specifically the structure of the Eurozone, is a large part of this problem. Either tighter fiscal and monetary integration, or a breakup, might actually work. But the current system is impossible, and it’s destroying the lives of the people who live in the unfortunate countries suffering through a forced depression.
The euro has helped both to create and sustain the crisis in Europe. First, it caused interest rates to plunge in southern Europe, encouraging countries such as Italy and Greece to go on a borrowing binge. Now the single currency rules out the options that postwar Italy and others traditionally used to cope with high levels of debt: inflation and devaluation of the currency. Neither policy was cost free, but they provided an alternative to the “internal devaluation” (otherwise known as wage cuts and mass unemployment) that is currently being urged on Italy, Greece and much of southern Europe.
The global financial crisis exposed the euro’s weaknesses. When it first became apparent that Greece was in serious trouble, in 2009, the EU set itself two tasks. The first was to resolve the Greek crisis. The second was to convince the markets that Greece is an isolated case that bears no resemblance to the rest of the eurozone. They have failed comprehensively in both tasks [...]
Some argue the destruction of the single currency will destroy the EU itself. But such alarmism risks becoming a self-fulfilling prophecy. Key European achievements such as the single market, border-free travel and co-operation on foreign policy preceded the single currency and they can survive its demise. Rather than insisting that the break-up of the euro is unthinkable, Europe’s leaders need to start planning for it.