Italy

As we have been claiming for months now, Italian banks will have no choice but to raise capital to prevent their undercapitalized status from stirring the insolvent bank vigilantes and making them into the next MF, or Lehman, or pick your favorite bankrupt bank metaphor. Today we get confirmation of this, after Reuters reported that Italy's UniCredit will proceed with a €4 to €7 billion capital raise. So far so good. Where it gets somewhat entertaining is the disclosure of who it is that will be "advising" UniCredit on its capital raise. Per Reuters, "Mediobanca and Bank of America-Merrill Lynch are advising Italy's UniCredit on a capital increase seen in a range of between 4 billion and 7 billion euros, although no formal mandate has been given yet to form a consortium for the operation, sources close to the matter said on Thursday. The sources said a decision on the size of the capital hike depended on a series of factors, including whether UniCredit would be allowed to calculate convertible notes worth some 3 billion euros as core capital." Did they just say Mediobanca and Bank of America advising another bank on... a capital raise? Uh, pardon our ignorance, but shouldn't Mediobanca and Bank of America be focusing on their own capitalization first before advising someone else? Does this mean that Bernie Madoff has somehow magically made his way to the Treasury Borrowing Advisory Committee and is now advising Tim Geithner on how to raise debt? Or that Jon Corzine is running for US Attorney General? Frankly, nothing would surprise us any more... Presenting the YTD performance of all three banks.

We have discussed this a few times over the last year and as Greece begins to show signs of defection, it is perhaps worth considering what a spoiled and chided sovereign might do in a temper tantrum. Peter Tchir, of TF Market Advisors, puts it best this morning: "Everything I have read over the past couple of weeks coming out of Italy, tells me that if there was one country prepared to "screw" the Euro and go it alone, it would be Italy.  They don't like Merkozy treating them like children, and they have a big enough economy that a dirt cheap Lire would make exports possible".

The duration of the European bailout was 48 hours give or take. And now reality is back in the form of the following headlines:

• Italian 10 Year BTP Yield surges to all time high 6.153% before ECB intervention takes it back to ... 6 122%
• Expressed in price, they have dropped to a record 90.697
• Italian-German 10 year yield passes 400 bps
• Italy CDS soar 22 bps to 427 bps
• Italy 5 Year yields bonds join drop, yield rises  to over record 5.91%

See a trend? The one thing Europe was trying to avoid, contagion spreading to Italy, has happened.

With the EFSF, Italian and Spanish debt all creeping higher in yield today and a disappointing Italian auction, we take a deeper dive into the mechianics of the EFSF and the paradoxically weak impact it may have as sovereign risk deteriorates. The [EFSF] idea works well when people aren’t thinking there is a real chance of default, but as that increases, the EU may wish they had stuck to their original plan of having raised 440 billion of cash that they could lend directly.  Basically, if the markets deteriorate, the first loss protection, is worth more, but provides less leverage.

Don't anyone say Italy is not willing to tackle austerity with the determination of a rabid dog: retirement age to be raised by 2 years in 15 years, and an epic €5 billion to be raised from privatizations.

Over the past few days, Italy has promptly re-emerged as a main cog in the illusion that Europe is a well-greased machine (yes, we know, funny) after it became clear that the country continues to refuse to implement any actual austerity measures following the requirement to do just that months ago when it got access to the ECB's sterlizied bond monetization scheme. In fact it got so bad that yesterday the entire Italian government was rumored to be on the verge of collapse as it was once again unable to reach a resolution on what the EU demands are prompt actions taken to raise pension and/or retirement age. According to the Telegraph, Italy may have found a compromise, one which actually ends the regime of Berlusconi... but not yet. Telegraph reports that Silvio Berlusconi has reportedly drawn up a "secret pact" under which he will resign in December or January, paving the way for Italy to elect a new government in March. "The embattled prime minister made the deal with his key coalition ally, Umberto Bossi of the devolutionist Northern League, in return for Mr Bossi's support for pension reforms, according to unconfirmed reports in two Italian newspapers – La Repubblica and La Stampa. Italy is under huge pressure from the European Union to reform its pensions system and extend retirement ages as part of a plan to rein in its enormous public debt and revive its moribund economy." "Don't make a fool of me in Brussels, and I promise that we'll go to elections in March," Mr Berlusconi told the Northern League leader, according to La Repubblica." This would all be great, if only for one small snag: the "plan", like everything else in Europe, is worthless. The FT reports that the compromise agreement "lacks specifics and risks falling short of what eurozone leaders have demanded ahead of Wednesday’s summit in Brussels....In the end, Umberto Bossi, the fiercely eurosceptic leader of the federalist League, made minor concessions that would raise the general retirement age to 67 years by 2026, but rejected changes to Italy’s length of service pension system that allows many workers to retire at the age of 61 with 35 years of contributions. Even Mr Bossi did not sound hopeful that the proposals would go down well in Brussels. In the past he has said he “doesn’t give a damn” about pressure from Europe over Italy’s pension system." He may change his tune once BTPs drop under 90 and go bidless.

With European coverage today about to confirm with absolutely certainty that the only option for Europe is to baffle everyone with intolerable and ridiculous amounts of bullshit, and failing that, to delay, delay, delay (we are already hearing of another summit in 4 days), probably what is most indicative of what to expect out of Europe is what incoming ECB president Mario Draghi said is the situation in Italy which he called is "confused and dramatic." That pretty much sums it up. Anyone expecting any actionable result out of the drama queen country or continent, will be disappointed. In the meantime here are sporadic news which attempt to paint a picture of the total confusion in Europe...

Even our non-polyglot readers will have zero problems understanding the response (in French) by Merkozy, when asked during the press conference, whether Italy, which has the second largest debt load in Europe at $2.2 trillion and inches behind German, will succeed in implementing promised 'reforms.' The wholesale laughter 19 seconds in the the clip, by not only the entire audience, but by Merkel and Sarkozy pretty much explains what the "next steps" in Europe are as the continent has now given up any pretense it is even trying to keep a serious facade on the upcoming serial defaults... and why 10 Year BTPs will need much more than just the SMP, EFSF and the hand of god to stay above 90 in the coming week.

Italy rejected the budget today. I can't imagine that it is because the opposition wanted more austerity. That must make the Slovakians even more eager to provide the EFSF with money to buy Italian bonds. The IMF has declared that they went to Greece (because they had purchased non-refundable tickets) but are going to give our money to Greece even though none of the alleged criteria were met. How long are countries going to let IMF control their money so whimsically? Since EFSF will likely be approved, I wanted to see what the Eurozone was going to do with all that "cheap" money. As you can see clearly from the graph, French bond spreads are widening relative to Germany, and EFSF spreads are widening slightly faster than that.

Fitch Ratings-London/Milan-07 October 2011: Fitch Ratings has downgraded the Italian Republic's (Italy) foreign and local currency Long-term Issuer Default Ratings (IDRs) from 'AA-' (AA minus) to 'A+' (A plus) and the short-term rating from 'F1+' to 'F1'. The Outlook on the long-term ratings is Negative. The Country Ceiling of 'AAA' has also been affirmed. The downgrade reflects the intensification of the Euro zone crisis that constitutes a significant financial and economic shock which has weakened Italy's sovereign risk profile. As Fitch has cautioned previously, a credible and comprehensive solution to the crisis is politically and technically complex and will take time to put in place and to earn the trust of investors. In the meantime, the crisis has adversely impacted financial stability and growth prospects across the region. However, the high level of public debt and fiscal financing requirement along with the low rate of potential growth rendered Italy especially vulnerable to such an external shock.

And here we go again. Ironically, this is nothing. Wait until S&P, which just telegraphed very loudly the next steps earlier, puts France on downgrade review...

As usual, a corrupt and pathetic Moody's continues to boldly not go where everyone else has gone before. Luckily, S&P, which had the balls to cut the US, has just done so to Europe's next domino, by downgrading Italy from A+ to A, outlook negative. Then again, this was pretty much telegraphed 100% earlier today as noted in "Italy Expected To Cut Growth Forecasts Further." Anyway, those incompetents from Moody's are next. Some of the choicest words: "In our view, weaker economic growth performance will likely limit the effectiveness of Italy's revenue-led fiscal consolidation program", "We have revised our base-case medium-term projections of real GDP growth to an annual average of 0.7% between 2011 to 2014, compared with our previous projection of 1.3%", "The negative outlook reflects our view of additional downside risks to public finances related to the trajectory of Italy's real and nominal GDP growth, and implementation risks of the government's fiscal consolidation program" and so forth.

Even though Europe is closed, and the requisite ES ramp appeared on cue just as expected, Reuters has released some news which will put the Risk Off trade solidly back on the books, after it announced that "Italy will shortly cut its growth forecasts for this year and 2012 to bring them more into line with those of independent bodies, but the prospects for public finances have improved due to an increase in value added tax, government sources told Reuters on Monday." It continues: "A government forecasting document to be published in the next few days following the austerity plan approved by parliament last week will cut the 2011 growth forecast to 0.7 percent from 1.1 percent and lower the 2012 forecast to "1 percent or below" from 1.3 percent, the sources said." Someone who will certainly be very unhappy with this news is Moody's which is already delaying cutting Italy (and said last week it will have to do something within the month), but this will make any additional delays impossible, as well as push the rating agency to trim the country's credit rating by more than just one notch.

"In light of the increasingly challenging economic and financial environment and fluid political developments in the euro area, Moody's is continuing to evaluate Italy's local and foreign currency bond ratings in the context of the risks identified. Moody's will strive to conclude the review within the next month."

The first Italian austerity package has not even properly failed yet (despite labor union protests to the contrary which for some odd reason believe that it has some chance of passing), and already Italy is preparing for a new round of "austerity" to appease those naive fools from the ECB so they buy Italy's otherwise bidless bonds for a few more weeks. From Bloomberg: "Italy may need a new budget- adjustment plan next month because a 54 billion-euro ($76 billion) austerity package to be voted on today won’t convince the European Central Bank to continue buying the nation’s bonds, the chairman of the Senate Finance Committee said. “How long can the ECB continue to buy Italian Treasury bonds?” Mario Baldassarri said in an interview in Rome today. “We may need another adjustment in three, four weeks which will be the real answer to the European Commission and to markets.” Because this time, unlike a month ago, it will be different. Berlusconi promises. As a reminder, Italy will vote on the current massively watered-down plan which is anything but austere later today, in a vote largely expected to pass. Said passage, however will do nothing to please Trichet, who will continue to remind Italy just who calls the shots now (oddly enough the ECB thinks that would be them... which explains the loving relationship between the Central Bank and a electorally challenged Angela Merkel). None of this changes the underlying dynamic which has become all too clear: the PIIGS have called Europe's bluff, and Europe blinked. Going forward expect much barking from the ECB and Luxembourg, warning the periphery to get its house in order... and absolutely no bite. Because everyone by now realizes that the balance of power is entirely on the insolvent countries' side. Europe can threaten to kick out a country, but as UBS demonstrated on Monday, the consequences of such a move, which would end the euro, would be up to and including that Keynesian wet dream: war.