Italy next week
Some stories in European press (La Stampa - Zero Hedge link) suggest that Italy is working on a very big loan package from the IMF. I have no doubt that there are ongoing discussions. There has to be. Either someone puts a finger in the dike or Italy goes tapioca.
That thought is difficult for me to fathom. How could we be so close to the brink? At this point there is zero possibility that Italy can refinance any portion of its $300b of 2012 maturing debt. If there is anyone at the table who still still thinks that Italy can pull off a miracle, they are wrong. I’m certain that the finance guys at the ECB and Italian CB understand this. I repeat, there is a zero chance for a market solution for Italy. Either the ECB (aka Germany) steps in and underwrites the debt with some form of Euro bonds or the IMF (aka the USA) steps in with some very serious money.
I have acknowledged in recent articles that I misread the Italian story. I didn't see this coming at the pace that it has. Italian bond yields more than doubled in a month. I was not alone in this very big misread. I believe it has caught everyone flatfooted. Central bankers and finance officials all over the globe are crapping in their pants.
I think the Italian story is make or break. Either this gets fixed or Italy defaults in less than six months. The default option is not really an option that policy makers would consider. If Italy can’t make it, then there will be a very big crashing sound. It would end up taking out most of the global lenders, a fair number of countries would follow into Italy’s vortex. In my opinion a default by Italy is certain to bring a global depression; one that would take many years to crawl out of. The policy makers are aware of this too.
So I say something is brewing. And yes, if there is a plan in the works it must involve the IMF. And yes, it’s going to be big.
Please do not read this and conclude that some headline is coming that will make us all feel happy again. I think headlines are coming. But those headlines are likely to scare the crap out of the markets once the implications are understood.
In the real world of global finance the reality is that any country that is forced to accept an IMF bailout is also blocked from issuing debt in the public markets. IMF (or other supranational debt) is ALWAYS senior to other indebtedness of the country. That’s just the way it works. When Italy borrows money from the IMF it automatically subordinates the existing creditors. Lenders hate this. They will vote with their feet and take a pass at Italian new debt issuance for a long time to come. Once the process starts, it will not end. There will be a snow ball of other creditors. That's exactly what happened in the 80's when Mexico failed; within a year two dozen other countries were forced to their debt knees. (I had a front row seat.)
I don’t see a way out of this box. The liquidity crisis in Italy is scaring us to death, the solution will almost certainly kill us.
The news announced last week where the IMF is providing EU countries a new "crisis" lending facility equal to 5Xs their IMF quota is a joke. What has been offered is a drop in the bucket against what is required. The La Stampa story today and this discussion are about something separate and distinct. What would be required is a step without precedent. It would dwarf what the IMF put forward just a few days ago.