FT, Wolfgang Münchau: Italy debt burden is a problem for us all

 Wolfgang Münchau, FT

We need extreme and co-ordinated policy to make it possible for Italy to ultimately stay in the eurozone

Perhaps the biggest question facing the economic stability of Europe is what happens if Italy continues to stagnate as it had done for the past 15 years. Will everything just continue as it is now, just a little bit more depressed?

I think it is high time to address the consequences of failure with more clarity than is usually done. Put bluntly, Italy’s economic position is unsustainable and will result in eventual debt default unless there is a sudden and durable change in economic growth. At that point, Italy’s future in the eurozone would also be in doubt – and indeed the future of the euro itself.

What we are seeing in Italy is the brutal dynamics of debt deflation – where the fall in the price level raises the real value of debt. Between 2007 and 2013, the ratio of Italian public sector debt to gross domestic product rose from 103.3 per cent to 132.6 per cent according to Eurostat figures. For this year, the Organisation for Economic Co-operation and Development expects it to rise to 137.5 per cent.

If Italy continues to stagnate in 2015 and 2016, the debt-to-GDP ratio will be heading towards 150 per cent of GDP. /.../

We are in a situation where we need a lot of extreme and co-ordinated policy action to make it possible for Italy to grow, service debt and ultimately stay in the eurozone. But policy so far has been neither extreme nor co-ordinated. Matteo Renzi, Italian prime minister, has promised radical reform, but not yet delivered. However, this is not enough. Italian debt sustainability requires policies at eurozone level that have so far been ruled out. This is where the eurozone’s success or failure will be decided.

Jeigu Europoje ir toliau trūks ekonominės paklausos, didžiausia valstybės skola užsienio valiuta pasaulyje nebus sumokėta.

Eurozonos likimas spręsis Italijoje.

Užbalansiniai Mario Draghi stebuklai

Corruption, EuroStyle: ECB Chief Draghi Fudged Italy’s Books to Secure Eurozone Entry, Italy Stuck With Derivative Losses

As readers of the financial press may recall, there was a kerfluffle over the fact that Greece had used a currency trades designed by Goldman in 2001 to mask the level of its indebtedness and secure Eurozone entry. Goldman continued to help Greece dress up its books and offered to intervene in 2009, although Greece turned them down then. [...]

A new story by Financial Times shows that Draghi and the ECB had far more to hide than the Greece scandal. It appears Draghi was directly involved in arranging similar, much larger transactions for Italy while Draghi was the director general of the Bank of Italy, in 1999. Draghi then went to Goldman. The FT also reports that Draghi’s deputy on these deals, who left the Bank of Italy in 2000, returned as director general in 2012 with Draghi’s support. Sure looks like payback time.
The scandal is coming to a head now because the Italian government is set to lose billions of euros as a result of restructuring of derivatives, including the 1999 derivatives, at the worst of the crisis. The FT stresses that all the details are not known, but the losses look to be troubling:

The report does not specify the potential losses Italy faces on the restructured contracts. But three independent experts consulted by the FT calculated the losses based on market prices on June 20 and concluded the Treasury was facing a potential loss at that moment of about €8bn, a surprisingly high figure based on a notional value of €31.7bn.

The names of the banks involved in these transactions have not been disclosed, but previous reports show that Morgan Stanley and JP Morgan have been among the Italy’s counterparties.
There are two, possibly three, ugly implications.
First, the revelation that Italy is facing previously undisclosed derivative losses comes at a time when periphery Eurozone countries are again under stress, including Italy. From Ambrose Evans-Pritchard today at the Telegraph:

Mediobanca, Italy’s second biggest bank, said its “index of solvency risk” for Italy was already flashing warning signs as the worldwide bond rout continued into a second week, pushing up borrowing costs…
The report warned that Italy will “inevitably end up in an EU bail-out request” over the next six months, unless it can count on low borrowing costs and a broader recovery….
Italy’s €2.1 trillion (£1.8 trillion) debt is the world’s third largest after the US and Japan….Italian 10-year yields spiked to 4.8pc, up 100 basis points since the Fed began to toughen its language in May. But Mediobanca is particularly concerned about the gap that has emerged between yields on short-term bills (BOTs) and longer-term bonds (BTPs) near maturity that expire at the same time. BOTs retiring on July 31 are trading at a yield of 0.48, while the equivalent BTP is trading at 0.74pc. The reason is that BOTs are protected from debt restructuring….
Mediobanca said the trigger for a blow-up in Italy could be a bail-out crisis for Slovenia or an ugly turn of events in Argentina, which has close links to Italian business. “Argentina in particular worries us, as a new default seems likely.”

Second is that given Draghi’s involvement in Italian books-cooking, it seems even more implausible than before that he did not know of the Greece deals with Goldman.
Third is that if Goldman was one of the counterparties to Italy when Draghi was at the helm of the Italian central bank, his subsequent employment looks an awful lot like a payoff.
The Bank of Italy and the ECB are certain to fight tooth and nail to defect questions about Draghi and might not be above using market stresses as part of their excuses for stonewalling. But the magnitude of these losses may galvanize the Italian public. The matter is now in the hands of the state auditors and the financial police, so how far this goes will also be a function of how they operate in the face of large public scandals.