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NY Times, Oct. 12, 2018
The World Is Due Another Financial Crisis. It Could Start in Italy.
By Jack Ewing and Jason Horowitz
History suggests that the world is about due for another financial
crisis. One of the places it might start, according to a growing number
of indicators, is Italy.
Many of the ingredients are there. A pile of questionable debt. Weak
banks. An erratic government. And a sizable economy able to inflict
collateral damage outside Italian borders.
Bond investors, always good for a coldblooded appraisal of a country’s
solvency, have been sounding the alarm. The Rome government’s populist
spending plans, widely regarded in financial circles as reckless, have
caused market interest rates on Italian debt to spike, threatening to
create a so-called doom loop that would ripple through the struggling
economy.
The proposed budget has exposed the seams in Italy’s governing
coalition, where one party favors small-business friendly tax cuts and
the other enormously expensive welfare programs. More broadly, it has
divided the populist government, which has vowed to press ahead with a
budget it views as a political imperative, and the Italian financial
establishment, which fears what the spending will do to the country’s
economy and its credibility and relationship with Europe.
You don’t have to be Italian to be worried about the repercussions.
Financial crises tend to arrive every decade or so, and Italy is near
the top of a list of flash points that could touch off the next one,
alongside Turkey’s economic and political turmoil, President Trump’s
trade war, Britain’s exit from the European Union, and a broad slowdown
in global growth.
But in contrast to the financial crisis that began in 2008, central
banks may not be able to come to the rescue this time, said Richard
Portes, a professor of economics at London Business School. They used up
much of their resources coping with the last meltdown.
“It would be very difficult for Mario Draghi to think of another way to
get out of the mess,” Mr. Portes said, referring to the president of the
European Central Bank.
That is why investors are so worried about Italy. The eurozone is still
recovering from a debt crisis that began in Greece in 2010. Italy, the
currency bloc’s third-largest economy, accounts for 11 percent of the
European Union’s gross domestic product — 10 times as much as Greece —
and has the potential to create far more damage.
Many of the country’s problems are longstanding, such as the unusually
high number of problem loans on its banks’ balance sheets and
chronically slow growth. Italy’s economy has still not made up the
ground it lost after the 2008 financial crisis. The new element is
Italy’s populist government, which to the horror of European Union
officials and bond markets is pledging money it doesn’t have to fulfill
campaign promises.
Unlike previous Italian governments that bristled at, but ultimately
complied with demands from, the European Union, Italy’s populists have
made their careers running against Brussels.
They are pursuing a brazenly confrontational course with the European
Commission, never mind the market reaction or the consequences for
Italian savers, who are among the biggest holders of government bonds.
“The enemies of Europe are those barricaded in the bunker of Brussels,”
Matteo Salvini, the leader of the anti-immigrant League and the
country’s most powerful politician, said this week in a news conference.
He has repeatedly called European Commission President Jean-Claude
Juncker and Economics Commissioner Pierre Moscovici the villains who
“have ruined Europe and our country” through austerity measures.
Under eurozone rules, Italy must submit its budget for European
Commission scrutiny by Monday. The proposed spending plan calls for a
deficit equal to 2.4 percent of G.D.P., a figure considered way too high
for a country whose total government debt equals 131 percent of G.D.P.,
more than double the eurozone limit.
The prior center-left government had proposed a budget with a 0.8
percent deficit, which would have allowed Italy to continue chipping
away at its total debt.
A significant portion of the new budget would go toward a broad welfare
program, a key campaign promise of the anti-establishment Five Star
Movement to its young, unemployed and frustrated base, many in Italy’s
depressed south.
“In a decisive manner, with this measure, with this budget, we will have
abolished poverty,” Luigi Di Maio, the political leader of the Five Star
Movement and Italy’s economic development minister, said in a television
interview last month.
A negative report on the proposed budget by Fitch Ratings on Wednesday
night has injected extra anxiety into the budget negotiations. In its
report, Fitch cited the “disorderly buildup” to the budget presentation
and the disagreement between Five Star and League on fiscal priorities,
the lack of detail on tax proposals and the gulf between the “high cost
of implementing core policy pledges and the objective to reduce public
debt.”
In addition, the hostile tone that the Italians have taken with the
European Union, the very thing that helped put them in power, “indicates
that the government sees political opportunities in attacking the E.U.’s
fiscal rules, especially in the run-up to European Parliamentary
elections next May,” the report said.
Fitch has signaled it could downgrade its rating of Italy’s debt, a step
that if matched by other ratings agencies would further raise the
government’s cost to borrow.
The government has cut some expenditures, but in categories that further
provoke Brussels. For example, Rome has suspended plans to acquire a new
missile defense system at a time when Europe is trying to appease Mr.
Trump by spending more on NATO.
The spending plan was “a significant deviation from the fiscal path”
recommended by European leaders and “is therefore a source of serious
concern,” Mr. Moscovici and Valdis Dombrovskis, the vice president of
the European Commission, wrote to the Italian government last week.
Officials in Brussels face a dilemma, though. They will lose credibility
if they fail to discipline an errant member. But if they take too hard a
line they will simply make Brussels a convenient scapegoat for Italian
politicians.
For that reason European leaders are likely to initiate a process that
could lead to sanctions, such as cutting off European Union funds, but
pursue it cautiously. “They will have to do something but they will take
their time,” said Grégory Claeys, a research fellow at Bruegel, a think
tank in Brussels.
The Italian government, at least for now, appears popular and immune to
electoral pain. When the Italian parliament passed the budget proposal
at the end of September, Mr. Di Maio and his allies in the Five Star
Movement took to the balcony of the Palazzo Chigi, the seat of Italian
government, and flashed victory signs as a crowd of lawmakers and
supporters below them chanted “Luigi! Luigi!”
But public support could begin to waver if investors continue to lose
confidence in Italian debt, which would have severe consequences for the
economy.
Italy is still a long way from the darkest days of the eurozone debt
crisis in 2011, when investors bid the market rate, or yield, on
government bonds to over 7 percent. But the yield has climbed
significantly since the populist government won elections earlier this
year, topping 3.7 percent this week compared with 1.7 percent in May.
Italian banks like UniCredit have large holdings of their home country’s
debt. When yields rise, the value of their bond holdings goes down,
eroding their capital and raising questions about their health.
UniCredit shares have slumped to about 12 euros recently from 18 euros
in April.
In an effort to preserve capital, banks then become more cautious about
lending. Consumers and businesses have to pay higher interest rates to
borrow, or might not be able to get credit at all, strangling the economy.
If economic growth slows and unemployment rises, fewer people pay taxes
and the government’s financial situation deteriorates further. Investors
then insist on a higher risk premium on Italian bonds — a higher return
— and the cycle repeats. That’s why it’s called a doom loop.
“Debt is the great multiplier of turbulence for Italy,” Luigi Federico
Signorini, the deputy director general of the Bank of Italy, told a
parliamentary hearing on Tuesday. “Oscillations in its value also have
effects on the Italian individuals, families, companies and financial
institutions that hold it.”
Polls show that Italians do not want to give up the euro, a fact that
may restrain the government. It has shown in the past it would react to
pressure, appointing a moderate, Giovanni Tria, as finance minister
after objections were raised to the initial choice, Paolo Savona, an
economist who had written about exiting the euro.
But Mr. Tria has been worn down by the lengthy budget negotiations and
subjected to humiliating attacks by the leaders of the League and Five
Star Movement. In an audio recording leaked to the Italian media, a
high-ranking official in the government who is also a prominent member
of the Five Star Movement threatened to fire bureaucrats under Mr. Tria
if they couldn’t find money to get the welfare measure in the budget.
On Tuesday, Claudio Borghi, the president of the budget commission in
the Lower House of Parliament who is a member of the euroskeptic League,
cut off Mr. Tria’s microphone during committee hearings.
Mr. Tria has insisted he is not considering resigning.
Provoking Brussels has been a winning political strategy for the current
crop of Italian leaders, and they show no signs of giving it up.
“We care about markets,” Mr. Di Maio said in a television interview last
week. But faced with a choice between bond yields and the Italian
people, he added, “I choose the Italian people.”
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