News From Italy: A Bargain is Struck?

The news out of Rome:

“Silvio Berlusconi has salvaged a compromise agreement on economic reforms with his coalition partners that commentators said lacks specifics and risks falling short of what eurozone leaders have demanded ahead of Wednesday’s summit in Brussels.” (http://www.ft.com/intl/cms/s/0/5945e250-ffba-11e0-89ce-00144feabdc0.html#axzz1bjQzVRpl)

The crucial point…the plan “lacks specifics and risks falling short”…

Prime minister Berlusconi and the head of his coalition partner, the Northern League, Umberto Bossi, negotiated the new compromise package to submit to other eurozone leaders.  Other than reaching some kind of agreement, the alternative is for Mr. Berlusconi to resign.

The prospects do not seem to be encouraging:

“Newspaper editorials on Wednesday said Mr. Berlusconi and Mr. Bossi may have staved off a collapse of their coalition for the time being, but at the risk of undermining a critical summit and failing to deliver the reforms Italy needs to lift an economy on the edge of a renewed recession.”

Mr. Bossi is not a fan of the European arrangement…a euro-skeptic.  Hence, his tradeoffs are substantially different from those of Berlusconi.  And, Mr. Berlusconi does not have much personal credibility…and little or no moral stature…to trade on.

In fact, Beppe Severginini in a Financial Post op-ed piece goes even further:

“How can the world’s eighth largest economy go on with a delusional prime minister, a weak government, an impotent opposition and its finances in disarray?” (http://www.ft.com/intl/cms/s/0/c78b1142-fe6e-11e0-bac4-00144feabdc0.html#axzz1bjQzVRpl)

How did someone like Berlusconi become prime minister in the first place?  Well, as one person commentated on my earlier post this week, Mr. Berlusconi became prime minister of Italy because everyone else running for the position was worse than he was.  Encouraging…

So where does that leave Europe?

Mr. Sarkozy and Ms. Merkel appeared to be applying the pressure to Mr. Berlusconi over the weekend.  This precipitated the efforts of the past two days. 

If the reports of the reform plan concocted by Berlusconi and his coalition are true and the plan really does fall short of what is necessary, the question becomes, will Sarkozy and Merkel “stick to their guns” and hold Italy’s “feet to the fire”?  Or, will the French and German officials back off and attempt to get by with something less than they stated was necessary. 

The crucial thing here, to me, is that the pressure on Italy was applied because several eurozone officials believed that the problems they faced were deep enough that an attempt needed to be made to “encircle” the major problems and not just work on individual nations on a case-by-case basis. (See my post “Italy is the Key to Solving the Euro Debt Crisis”, http://seekingalpha.com/article/301607-italy-is-the-key-to-solving-the-euro-debt-crisis.)  Whereas in the past, the European Union began with the smallest, weakest link in the chain and then moved up to the next, larger, crisis, the current move was to include the third largest economy in the EU along with the weakest, Greece, and this, then, would include all that was in-between, like Spain and Portugal. 

Now, this may not be achieved.  We wait to see how Mr. Sarkozy and Ms. Merkel respond to the new Italian proposal.

But, this is not all.  The banking situation in Europe still lingers. (http://seekingalpha.com/article/301369-europeans-facing-more-of-a-haircut-than-preciously-thought) European banks are balking over the proposed debt “haircuts” and the new proposed capital requirements. 

It would seem that if Sarkozy and Merkel “back off” any on the Italy effort, given the pressure put on Italy over the weekend, that the banks will smell the weakness and put up even more resistance to the effort to write down the debt issues under consideration as far as needed. 

This, of course, puts the eurozone in a more tenuous position because lack of cooperation by the banks on the write-downs has implications that relate to a “triggering event” which might set off “bankruptcy” questions leading to payoffs on Credit Default Swaps.  The possibility of this occurring raises the specter of contagion in the financial sector, ala’ the Lehman Brothers affair, something eurozone officials sincerely want to avoid.

It seems as if European officials are running out of choices.  Yet, as we have seen in the past, European officials are masters of the art of squirming out of difficult spots and postponing solutions for another time. 

The betting still seems to be on the conclusion that no real leaders will arise in Europe to resolve the problems that Europe faces.  We can only hope for a better outcome

Can Berlusconi Pull It Off?

In my last post I wrote about the role that Italy might play in any solution to the European sovereign debt crisis. (See http://seekingalpha.com/article/301607-italy-is-the-key-to-solving-the-euro-debt-crisis.)

It seems as if the pressure applied on the Italian prime minister might be paying off.

“Silvio Berlusconi has called a cabinet meeting for Monday evening to consider new economic reform proposals after the prime minister returned to Italy following his humiliation at the eurozone leaders’ summit in Brussels.

The emergency meeting was called in response to demands by the summit that Italy prepare legislation on structural reforms before the next meeting of eurozone leaders on Wednesday.” (http://www.ft.com/intl/cms/s/0/ead92fb8-fe18-11e0-a1eb-00144feabdc0.html#axzz1bjQzVRpl)

Mr. Berlusconi, in the face of political pressure and financial market pressure, is going to propose some “tough” measures to his coalition cabinet.  But, his Northern League coalition allies are flat out against some of the things he has presented.  Others in the coalition are seen as too divided internally to “agree on tough reforms”.

Still, Mr. Berlusconi is giving it a try.  His embarrassment in front of European Union members has been substantial.  It appears that he is attempting to “save face” before the eurozone officials assemble again on Wednesday.  An alternative, given that Berlusconi has been regularly losing support, is for him to resign in the face of too much opposition within the ruling coalition. 

Financial markets have also not been kind.  On Monday, the spread between the 10-year Italian BTP benchmark bond and the equivalent German issue jumped to 388 basis points.  The near term high for this spread is slightly more than 400 basis points.

Moody’s dropped the rating on Italian bonds three notches on October 4: Standard & Poor’s downgraded the Italian debt about a month before.  The rating agencies are poised for another possible lowering of the rating. 

Mario Calabresi, editor of Turin’s La Stampa newspaper stated the “we (Italians) are the sick man of Europe…”  As I stated in my last blogpost, the situation in Italy is comparable to the situation in Greece.  This can be seen as the cause of the current hostile focus on Italy by others in the eurozone. 

In this previous post, I argued that officials of the EU may finally be accepting the seriousness of the problem they face; that the issues now faced by the eurozone are solvency issues and not liquidity issues; and that the problem cannot be solved just on a state-by-state basis. 

Can Berlusconi bring this off?

I’m not sure he can.  But, this latest humiliation may really bring home to some Italians that they are not going to get “off the hook” this time.  Like Greece, efforts to bring on the reforms in Italy will result in more protests and riots like the ones seen in Greece and elsewhere in Europe. 

 
The times they are a changin’…

I’m not sure that the changes that are coming are the ones imagined by Bob Dylan when he wrote this line.  But, times have changed and societies and cultures are going to have to adapt.  Not everything is happening in “the Arab Spring.”       

European officials really seem to be getting serious now.

“European negotiators have asked Greek debt holders to accept a 60 per cent cut in the face value of their bonds, a hardline stance that far exceeds losses agreed in a deal between private investors and eurozone authorities three months ago.“ (See http://www.ft.com/intl/cms/s/0/ff349958-fe58-11e0-a1eb-00144feabdc0.html#axzz1bjQzVRpl but also see my post of October 23, http://seekingalpha.com/article/301369-europeans-facing-more-of-a-haircut-than-preciously-thought.)

I am thinking that many European officials are tired, tired of going over the same thing month after month after month.  Maybe, just maybe they are realizing that unless they really get their “arms around the problems” that the difficulties will just continue to march along.  In essence, maybe, just maybe, they are coming to the conclusion that “kicking the can down the road” doesn’t work. 

Let’s hope Mr. Berlusconi sticks to his guns and is able to pull off the reforms needed to allow Europe to move ahead.  Time really seems to be running out.    

Italy is the Key in Europe

It seems to be boiling down to this.  Italy and its prime minister Silvio Berlusconi are the evolving focus of any acceptable solution to the European sovereign debt crisis. 

There are, I believe, two reasons for this focus.  First, Italy is the third largest economy in the European Union.  Thus, moving it into the spotlight leapfrogs the problems of Spain and Portugal and others in terms of impact.  If Italy can be “tamed” then Spain, Portugal, and others will have to fall in line.

Second, Italy, within the European Union, is most like Greece in terms of fiscal irresponsibility, governmental patronization, and lackluster economy.  If both Greece and Italy take steps to correct their situations, then other troubled countries can justify stronger efforts to straighten out their problems as well. 

Another factor is that Silvio Berlusconi has become a characterization of European leadership…or the lack thereof…given his personal as well as his public tribulations.  And, this does not include his recent disputes with others, like that with French president Nicolas Sarkozy, over the makeup of the board of the European Central Bank.  Berlusconi, it seems, must be brought into line...even though he is just barely hanging onto power now.  

By focusing on Italy, the European Union is, in a sense, attempting to “get its arms around” the problem.  The EU efforts of the past have started with the smaller countries with the idea of working up the ladder as the need arose to deal with larger and larger countries.

By bringing Italy in at this time, the EU seems to be admitting that the problem is more fundamental than it had assumed in the past and that the problem is one of solvency and not the liquidity of the sovereign debt.  

Furthermore, the EU seems to be saying that more fiscal coordination needs to be achieved within the European Union itself and to gain this coordination, even the larger countries, like Italy, must submit to greater oversight and community discipline than had originally been built into the organization.    

With the crisis, it has become more and more obvious that for the countries of the European Union to really benefit from the creation of a common currency, greater fiscal union must be achieved as well.  Painful as it may be to some to accept this reality, I don’t believe that there is really much support anywhere for the breaking up of the currency union.

The European Union may finally be getting someplace, although I don’t want to be too optimistic.  Up to this point, the EU has just been “kicking the can” down the road.  It has continually avoided the seriousness of the situation; it has not accepted the reality of the solvency issue; and it has attempted to deal with problems piecemeal. 

As a consequence, many analysts have claimed that it would be better for some nations to leave the currency union or for the Euro to be eliminated all together. 

The fact is, the benefits of the currency union have been sufficiently great that the members of the EU really don’t want to see it go away. 

The “big bump in the road”, however, has been the need for sovereign nations to give up some of their sovereignty on the fiscal front, something they have, understandably, been reluctant to give up.  As a consequence, the path to greater fiscal union has been winding and painful.  No one, willingly, wants to look like the pansy.

By putting the pressure on Italy, the European Union is accepting the seriousness of the situation; it is accepting that the primary issue is one of solvency and not liquidity; and it is finally trying to encircle the problems that exist, not deal with them one-by-one.

This does not mean that the crisis in Europe is over.  There are still many “bumps in the road” that must be smoothed over. 

However, to me, putting Italy into the spotlight raises some hope that the officials in Europe (I am not willing to call them “leaders” yet) may finally be moving in the right direction.

Now Back to Europe

Silvio Berlusconi, Italy’s prime minister spoke to the Italian Parliament yesterday about the economic and financial situation facing Italy. 

Mr. Berlusconi “pointed the finger at speculators, global economic weakness and general problems in the eurozone.” (http://www.ft.com/intl/cms/s/0/088747fc-bdf5-11e0-ab9f-00144feabdc0.html#axzz1TyUqwXts) 

These words were an almost exact copy of those issued by the Greek government, the Irish government, and many others from within the eurozone over the past year or two. 

Gotta stay on message…the problem is “out there”!

Now that we have a modest pause in the news coming from the United States concerning sovereign debt and all that, we can return to the European sovereign debt situation…which is far from resolved.

When are people in Europe (remember that there are no leaders in Europe, “In Europe the Issue is Leadership”, http://seekingalpha.com/article/280658-in-europe-the-issue-is-leadership) going to realize that “kicking the can down the road” is not going to get them out of the situation they are in. 

In fact, as southern Europe continues to burn, the banking system in Europe is having to endure greater and greater stress. (See, for example major articles in the New York Times, http://www.nytimes.com/2011/08/04/business/global/europes-banks-struggle-with-weak-bonds.html?ref=business, and the Wall Street Journal, http://professional.wsj.com/article/SB10001424053111903885604576486671709242408.html?mod=ITP_moneyandinvesting_0&mg=reno-secaucus-wsj.) Only very short term loans seem to be available between banks but even these loans require borrowers to pay a premium over similar borrowing costs in the United States. 

The cost of borrowing 10-year money in Italy has now risen above the “crisis” level of 6 percent this week and Spain is now borrowing at interest rates not seen since the creation of the Euro.  Even Belgium and France are facing near term highs in borrowing costs.

As I wrote yesterday, the problem is that there is too much debt outstanding in Europe (and America) both in the private as well as the public sectors.  We, in the Western world, have lived off of the debt idol for too many years (See http://seekingalpha.com/article/284276-the-problem-too-much-debt).    

 How do we determine whether or not there is “too much debt outstanding”? 

In my opinion, an exact answer cannot be given.  We try and measure this by using statistics like government debt to GDP ratios, or, government deficit to GDP ratios, and the like.  But, we are dealing with human beings and ratios like these can only provide hints at debt loads and clues to times when debt burdens become excessive and unsustainable.

When do people start to realize that they have to make decisions about how they allocate their income rather than just keep spending on everything they want?  When do governments realize that they can’t fund every good social cause presented to them?  When do businesses realize that they just can’t continue to raise their return on equity by adding more financial leverage to the balance sheet?

There is no exact answer to these questions.  Economics is not an exact science no matter how much economists like to project this image to the world. 

And, the Keynesians argue that added spending stimulus will cause consumption expenditures to increase and this will get the economy going again, or, incentive for businesses to increase capital investment will get the economy going again.

Keynesian models have never adequately handled the issue of debt and financial leverage.  One reason is that debt levels and financial leverage are not always limiting factors in consumer and business spending.  In fact, during the early stages of a period of credit inflation, the greater availability of debt and financial leverage may have a positive influence on consumer and business spending. 

That is, debt levels and financial leverage may be positive influences on economic activity…before they become a negative influence. 

This is one of the problems in trying to understand human behavior.

But, back to the situation in Europe.  The world has changed.  The old models are not working and new ideas must be introduced into the efforts being made to get control over the crisis. 

Maybe this is not going to happen until the “old guard” of top government officials is replaced by someone new.  Continuing to try and govern using the assumption that the problem is “out there” is not going to work. 

The problem is with the governments and their officials and until this is recognized I don’t see Europe getting its act together. 

And, the longer it takes for the eurozone to get its act together the greater the opportunity for the BRICS and other emerging nations to prosper and overtake the “ancient regime” now governing Europe.

The United States cannot ignore this dilemma for it faces similar problems.  And, the government of the United States is emulating Europe by claiming that the cause of its problems is “out there” and by postponing any real solutions until a later date. 

The world has changed.  As the West went through a philosophical and social change after the Second World War, we are now going through another sizeable and traumatic change.  But, to stick with existing models of the world and, consequently, say that the problems are “out there” will just “kick the can further down the road”.  It will solve little or nothing.