Global Crisis/Innovation Blog
Euro Crisis: Italy is the REAL Problem!
By Shlomo Maital
If little Greece (11 m. people) and tiny Ireland (6 m. people) rattled Europe’s windows, because of their debts, Italy is about to blow up Europe’s shaky house. Here is why. Italy is huge (60 m. people, $2 trillion economy, $34,000 per capita GDP), and nearly bankrupt. Italy has the world’s third largest bond market, and its public debt is 120 per cent of GDP. (The comparable figure for Greece was 115 per cent in 2009, but that will rise to 149 per cent, says the IMF, by 2013). According to the Financial Times:
“Global banks’ exposure to Italy dwarfs their exposure in the three eurozone countries that have already been bailed out – Greece, Portugal and Ireland. In fact, at $262bn, the aggregate sovereign claims of foreign banks on Italy exceed their combined sovereign exposures to Greece, Ireland, Portugal and Spain, which total about $226bn, according to research by analysts at Collins Stewart.”
Who holds Italian Government bonds?
“French banks hold nearly $98bn worth of Italian sovereign debt, while Germany holds $51.2bn, according to the Bank for International Settlements. Italy is such an integral part of the financial system that most developed countries have a material exposure – Japan, for example, has a sovereign exposure of $29bn, according to Collins Stewart. Within Italy itself, about 65 per cent of domestic banks’ own equity is exposed to the sovereign [debt], according to the Bank for International Settlements.”
In other words: Default by Italy on its bonds will bring down Italian banks, and severely shake banks in France and in Germany.
How close is Italy to default? Close. In the past few days, interest rates on Italian bonds have risen to three percentage points higher than rates on German bonds. Why? According to The Economist, “this week’s anxiety was caused in part by a quarrel between Silvio Berlusconi, the prime minister, and Giulio Tremonti, the finance minister, and by uncertainty over the passage of an austerity budget.”
What a superb time for Italy’s skirt-chasing Prime Minister to quarrel with his Finance Minister. The $68 b. budget cut passed Italy’s Parliament – but its shaky government and embattled PM bode ill.
While everyone watches Greece, Italy has begun a dangerous slide down the slippery slope of higher interest rates, rising risk premiums and increasing difficulty to recycle its bonds. According to one expert, if the risk premium on Italian Government bonds rises to 5 percentage points above German bunds, Italy will be bankrupt. Right now, the gap is 3. It is worth thinking carefully what it might mean if Italy needs a bailout. Who will bail it out? By how much? What will be the terms? I expect a lot of European bankers and officials are losing a lot of sleep over Italy. Greece, in comparison, will seem like a tea party.
TIMnovate 
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July 26, 2011 at 4:55 pm
Joseph
Dear Prof. Maital as you taught to us here is my story about Italy:
Today Christine Lagarde, president of International monetary fund declared that she is in favor of a severe 2 years period of austerity in Europe. Now austerity means also very low economical growth, and for Italy , which is very slow in terms of growth, will be a huge economical and social problem. So I agree with you Italy is a Real Problem…..and also the Italian society is becoming a real problem.
July 26, 2011 at 5:01 pm
timnovate
Joseph, thanks for your narrative. I deeply regret that Christine Lagarde was made IMF Director, rather than Stanley Fischer. Lagarde is a lawyer, not an economist. Moreover, she is now singing the traditional IMF tune, which has only one note, “austerity”. For decades, the IMF has thrown societies into turmoil, from South Korea to Argentina. The tune the IMF should be singing is really, “growth, competitiveness, vision, hope”. But the IMF does not know that tune, and never will. The only consolation is this: the IMF has turned out to be a very very minor player in the European financial stability plan. Let’s hope it remains on the sidelines. Italy resembles my own country Israel. Its people are tremendously resilient and sometimes are at their best during great turmoil. I believe this will be the case in the coming two years as well. best wishes, Shlomo