Three months ago, in exchange for the ECB's expansion of its sterilized monetizations of bonds to include Italian BTPs, allegedly the only backstop that has prevented Italian bonds from experiencing an all out collapse to date, Italy was presented with a list of strict "austerity" demands, among which were spending cuts, higher revenues and labor reform. Since then none of these has occurred... or will occur, simply because Berlusconi has no control over the government, yet neither does anyone else, although everyone in the local government enjoys having a scapegoat for the total chaos. It appears that the ECB has just made it clear that the status quo is about to end, unless Italy does in fact push with something. And unlike other cases, where politicians on both sides of the table are happy to spout rhetoric while knowing well that nothing will change, in this case, courtesy of Italy largely untenable debt profile in which €166 billion in debt and interest are due in 2012, the ECB will have no choice but to play hard ball. Reuters has just confirmed that, reporting that The European Central Bank often discusses the possibility ending the purchase of Italian government bonds if it concludes Italy is not adopting promised reforms, ECB Governing Council Member Yves Mersch said. "If we observe that our interventions are undermined by a lack of efforts by national governments then we have to pose ourselves the problem of the incentive effect," Mersch said according to extracts of an interview with Italian daily La Stampa to be published on Sunday. In other words on Monday the market will have to not only digest the implications of what the implications of the Greek vote of confidence are (last we checked G-Pap is still PM, and likely will be for quite a while), but also what happens now that the ECB has issued an ultimatum to Berlusconi to get his house in order. The problem is that he can't. Not without stepping down, that is. At that point the Italian pseudo stability that everyone has been taking for granted knowing full well it is nothing but an illusion, will fall and expose all the rot underneath. At that point we will truly see just how "hedged" all those Primary Dealers are, who have perfectly offsetting short positions to all their longs.
And here is what an ECB ultimatum sounds like:
Asked if this meant the ECB would stop buying Italy's bonds if it did not adopt reforms it has promised to the European Union, Mersch, who heads Luxembourg's central bank, replied:
"If the ECB board reaches the conclusion that the conditions that led it to take a dec
ision no longer exist, it is free to change that decision at any moment. We discuss this all the time."
Since the ECB resumed its bond buying programme (SMP) around three months ago it has purchased some 100 billion euros of government bonds, a majority of which are thought to be Italian BTPs.
Mersch said the ECB did not want to become a lender of last resort to help the euro zone solve its debt crisis and said it was concerned that its job could be made more difficult by governments that "don't meet their responsibilities."
And the punchline:
"Our job is not to remedy the errors of politicians," he said.
No, it is merely to issue long overdue "or else" statements. Yet since the EFSF is unable to raise even €3 billion EURs to fund the Irish bail out, we are fairly confident that the ECB will be purchasing Italian bonds for a loooong time, because Berlusconi has figured out all too well just who it is that has the Mutual Assured Destruction trump card, and who stands to lose the most if said Destruction is indeed Mutual.
As a reminder, here is what the Italian debt/interest repayment schedule looks like. Good luck.