Italian Spreads: Quick answers to tough questions

(this column was written for the Metro italian daily edition) 

In another day of drama in the financial markets the spread between 10years BTPs and German  Bunds rose to the record (since the Euro) high,  575 points, with the 2years yields on BOTs reaching 7.5 % percent, higher than the 10 year Treasury bills, 7.48%. Let’s briefly consider 

  1. what’s going on in financial markets?
  2. how much are the costs for  the budget?
  3. why is all this happening?
  1. The spike in interest rates reflect the investors beliefs that there is a probability of about 10% that Italian bonds will halve their  value. Hence investors require higher returns to roll over the bonds. Moreover, risks are concentrated in the short term, this explains why short-term yields exceeds the long-term yields. 
  2. This year about 300 billion bonds will come due, hence an increase of two percentage points in interest rates involve about 6 billion additional servicing costs per year, about two-thirds of the fiscal maneuvers of 2011. But what is really worrisome is that  apart from the European Central Bank, today there are very few investors willing to renew the bonds. Since tax revenues barely cover government expenses (excluding interest) we may soon be forced to suspend interest payments and repayment of principal on debt, becoming insolvent (unless new tax increases and/ or new expenditure cuts are enforced). 
  3. All this has is happening because the crisis in Greece, Ireland and Portugal has given a “wake up call” to international markets, which have finally figured out that Italy is burdened with an enormous debt, and can fail, while Europe is unable/unwilling to pay for our bills. Furthermore, the announcement that Mr Berlusconi’ resignations will be postponed only after the approval of the measures agreed with Brussels, has created new uncertainty about whether/when Italy will finally have a government capable of dealing with the emergency.(Italian version on Metro, 10 November, 2011)