You will remember that back at the start of August in Banking the Sopranos I took a look at Italy’s debt profile and suggested that a) the markets were going to realise that Italy is a much worse risk than Spain and b) that the scale of the Italian liability is such that the power of extortion lay with the Italian side in its dealings with the EU. The Italian government then — in a stroke of comic genius — promised to legislate to make itself solvent.
Two months later we have senior IMF officials saying the Fund is ready to buy Italian debt, and northern Europe (Germany) readying to recapitalise banks such that they can survive big write-downs in ‘peripheral’ country sovereign bonds. The Sopranos look to be almost home and dry without even having to make Mrs Merkel an offer she can’t refuse.
But have the Germans really thought this through? Even if German banks had to write down 50 percent of the value of their (Greek and) Italian bonds they could manage with government back-stop of Euro100 billion, or less than 3 percent of GDP. It is a heavy price, but the return would include pushing Italy out of the Euro as a very profound lesson to other EU miscreants (particularly the eastern European periphery) and giving a world-first lesson about moral hazard to the banking sector, which would eventually have to pay off the write-down. People say that Italy is an important market for Germany, but given the condition of the place it is not going to be a growth opportunity for anyone. Sometimes, as the Chinese say, you need to cut a monkey’s head off to scare the chickens.
I say all this as someone whose family assets are largely concentrated in Italy. We have more than most to lose. And yet I think it would be better to throw Italy to the dogs than to move forward with a bail-out that enforces no fundamental structural change. Either Italy should be inside the Euro with a dramatic structural reform programme led by the IMF, or else outside it with a debt reduction but no one to turn to but itself. As I have written before, if Europe wants a more worthy cause for its patience, why not try Turkey?