I can’t really describe how important it is that the markets are now turning their attention on Italy.  Italy is simply too big to bail.  With debts of $2.5T it is the equivalent of Greece, Ireland and Portugal combined and represents 25% of ALL Eurozone debt.  It’s hard to believe that the core nations would be willing to bailout Italy without first conceding that the entire EMU has failed.  In a recent strategy note Morgan Stanley emphasized this point:

“Too large to rescue. However, the recent spreading of the debt crisis to Italy, the euro area’s third-largest economy and the third-largest government bond market in the world, has significantly increased the stakes for policy-makers. Italy is not too large to fail, but in our view, it is too large to rescue, if this ever became necessary. We expect a combination of Italian fiscal austerity measures to be finalised soon and additional euro area-wide measures such as an agreement on a second Greek rescue package and an increase in the scope and flexibility of the EFSF, possibly coupled with a reopening of the ECB’s bond purchase programme, to help contain the crisis (for more detail, see Cross-Asset Navigator: Crisis: Response, July 13, 2011, page 3). We are mindful, however, of the high and rising risk that severe policy divisions between and within the euro area governments prevent agreement on such stop-gap measures, which would raise the spectre of a much larger crisis, recession and, potentially, a break-up of the euro (see also Euro Wreckage Reloaded, April 14, 2010). “

Source: Morgan Stanley


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Greedsgood

    Absolutely agree. The markets are probably holding up better than could be expected due to the primary distraction of the debt-ceiling fiasco. Once that is settled (a big yawn event), the focus could turn back to the EU and the too big to bail countries (Italy & Spain) which are looking more scary on a daily basis – Greece 2-yr @35% looks like haircut is a foregone conclusion.

    Not sure if you coined the “too big to bail” phrase, or borrowed from another, but I can see this becoming the new mantra for 2011/2012.

  • BB


    When does the stock market start to reflect the current reality?

  • Cullen Roche

    When it’s too late :-)

  • BB


  • Roger Ingalls

    Wow, a priceless comic two-fer!

    Too big to bail, and then your response to BB…

    Can I get a rim shot? Ba da bang!

  • Mountaineer

    Have to keep perspective on this; the ECB can always write the checks. Trichet is in over his head, but every step of the way he has implemented policy with one goal in mind, saving the EU’s financial institutions. If Italian spreads don’t start tightening I would fully expect the ECB to come in heavy within the Euro bond markets. German inflation be damned. Long term the structural imbalances have to be addressed, unification or dismemberment, but only political will is needed to keep the charade afloat for the next few years.

  • George H

    I thought Spain is already too big to bail. Isn’t Spain in a more dire situation than Italy?

  • Cullen Roche

    100% right, but I guess my point is that Italy brings in the real risk that the core just says: “enough is enough”. Then we start getting real haircuts and an interesting scenario….Politically, I wonder if Italy is too big to bail. I could be wrong of course. Maybe they’ll swallow Italy as well….But I doubt it.

  • http://pragmaticcapitalism michael schofield

    Ride the Fed liquidity wave- or the Big Short II? Or both? Could get busy around here. I won’t pass up the short but seeing it sure would suck.

  • Tom Hickey

    Looks like the EZ may be headed into full-on crisis mode if they don’t act ASAP to stem the hemorrhaging. This would like result in the kick-off of the second leg down in the GFC. Systemic risk looks to be huge and it’s very opaque. Core CDS spiking, too.

    Euro debt crisis migrating to the core

  • Mountaineer

    I can’t see Italy either. At that point you’ll get something drastic. Either EU wide write-downs and restructurings assisted by ECB-backed recapitalizations or some form of Euro bond, maybe with an explicit/implicit yield cap from the ECB. Traditional bailouts just won’t do, the core simply can’t handle it.

  • Daniel

    why would the core say “enough is enough” when the ECB does the job? Maybe at first, there would be an outcry but then there is another earthquake, terror attack or world championship…
    It’s politically (and maybe also economically) not possible that germany takes over italys debt, italys debt is larger than germanys although the economy is smaller and in addition to that, Italy is really some kind of failed state. But explaining that would take too far…

  • Daniel

    well…as long as the 10 year bund is still trading below the inflation rate, I can’t really say that these CDS spikes make me worry

  • prescient11

    Long gold in euros, anyone?? Bueller??

  • Cullen Roche

    Who really runs the ECB? :-)

  • Tom Hickey

    The problem is that perception becomes reality. I see that Ray Dalio is predicting collapse. Views of people like him move markets.

    “Dalio believes that some heavily indebted countries, including the United States, will eventually opt for printing money as a way to deal with their debts, which will lead to a collapse in their currency and in their bond markets. “There hasn’t been a case in history where they haven’t eventually printed money and devalued their currency,” he said. Other developed countries, particularly those tied to the euro and thus to the European Central Bank, don’t have the option of printing money and are destined to undergo “classic depressions,” Dalio said. The recent deal to avoid an immediate debt default by Greece didn’t alter his pessimistic view. “People concentrate on the particular thing of the moment, and they forget the larger underlying forces,” he said. “That’s what got us into the debt crisis. It’s just today, today.”

    “Dalio’s assessment sounded alarmingly plausible. But when one plays the global financial markets a thorough economic analysis is only the first stage of the game. At least as important is getting the timing right. I asked Dalio when all this would start to come together. “I think late 2012 or early 2013 is going to be another very difficult period,” he said.”

    Read more

  • Daniel

    from fall on, it will be an italian guy :D

    Seriously, the ECB takes now greek bonds that trade at 50% (if they trade at all) as collateral, would some kind “credit easing” really be such a big step?

    The ECB can be quite pragmatic if it has to be, see fall/winter 2008/09

  • The Dork of Cork

    Interesting Italy Vs USA bond analysis from the FT.

    Yee guys have a extraordinary privilege

    see : Italy vs US: playing a different game –

  • REN

    I’m trying to understand how Europe is different than the U.S. If I’m wrong would somebody please correct me.

    My understanding is that new money sources at commercial banks. For example, a European government issues IOU’s to commercial bank; bank then issues new money to said government. European governments would see their incoming revenue as both taxes and IOU borrowing. There is no way to pay off the IOU bonds, other than raising taxes, and keeping Government consumption low. (Or, perhaps revenue could be had by selling off public assets to the private Bankers, who then get to use the asset as a rent seeking toll on society.)

    The Lisbon treat prevents the ECB from funding government deficits.

    Europe’s situation is like if Washington were not able to share revenues with States (which is what has kept our states afloat). The private banking sector in Europe sources all new money, and thus the private sector somehow must be responsible for stimulus? Since the private banking sector can only create expensive credit money, then low cost stimulus is not possible. Private bankers have made it so that governments have to borrow their own credit.

    The ECB does have a keyboard for making new money, but it is used only within their banking sector. It cannot be used to bail out governments.

    Greece’s socialist government spent high on the hog, making bonds to bring in extra money, to then pay for people to live above their means. If there is a balance sheet recession, there is no way to create new money at the Vertical level, or use fiscal policy, to fill in the void.

  • The Dork of Cork

    Yes but the ECB can produce Euros at will – those Euros have no real relationship with any goverment.
    A simplfied ECB balance sheet is Gold on its assets & cash on its liabilities.

    European Oil inflation is needed now anyhow as too much revenue is being exported to Russia & Arabia.
    But America can just pretend that food & energy does not matter as it can write itself global reserve assets at will without much change to its physical economy.

  • jt26

    There could be a regulatory answer:
    – suspend trading, margin limits, short ban
    – ban CDS
    – requiring citizens and companies to hold i-bonds
    – …
    Of course, we all know what happened in the great short unwind of July 08!

  • Schnuzzle

    There’s a lot of speculation that China is actually pulling the strings of the ECB puppets. If they are, I don’t see them helping with PIIGS debt. EURUSD tweaking maybe…

  • JWG

    If the ECB does not do whatever it takes with keystroke Euros to support PIIGS sovereign debt, it is beginning to look like the central bankers are out of ideas in this latest phase of the crisis that began in 2008. The total debt burden of the PIIGS that is now destabilizing may be so large that the ECB believes that to backstop it via QE asset purchases will result in destabilizng the Euro from another direction. Bernanke might be tempted to create a few trillion in keystroke dollars for swap lines and an indirect Euro bailout as in 2008, except that this time it might produce a Congressional backlash he can’t control. Banning naked CDSs, naked shorts etc. will be too little too late.

    It’s the fourth quarter of the Super Bowl of money. The central banks are clinging to the lead but the bond markets are threatening to score and put the game away. Coaches Trichet and Bernanke are oddly quiet; are they planning to all out blitz the markets and try to turn the game around? Stay tuned.

  • JWG

    One more thought. Most of the European banking system has gorged on debt related to the PIIGS. The stress tests were a naive and desperate public relations attempt that didn’t work. The ECB might follow the Fed and TARP and use keystroke Euros to recapitalize the European banking system and leave PIIGS sovereign debt to its fate in the markets. That might be less of a risk for the Euro than the ECB trying to QE every PIIGS sovereign bond at par no matter how terrible it looked, which is the only alternative to a systemic recapitalization.
    What a mess.

  • Dr. Oliver Strebel

    Spain now has AFAIK only syndicated bond auctions, where a preselected circle of buyers participates. Italy has 20 bln of 10 y bond which mature on 01.08.2011. So it makes more sense to talk abount Italy to get more interest ;).

  • Dr. Oliver Strebel

    Italy never fulfilled the conditions necessary to enter the Euro-zone. Nevertheless it was allowed to participate by sheer political arbitraryness.

    The only way out of the Euro-Desaster is to stop political arbitraryness and idiotic deficit spending of governments.

    Sure, trading imbalances hit the weaker european countries hard, if they do not have their own currency. This is a long known fact and therefore it was a silly political mistake of the weaker countries to participate in the EMU.

    A closer political unification of Europe under the present political regimes will be performed as sloppy and conceptually flawed as the introduction of the Euro. God save Europe from the idealistic and ignorant european politicians, which think they are doing good things but in fact are ruining Europe.

  • Dr. Oliver Strebel

    Personally I think the indroduction of a northern and a southern Euro could bring considereable relief to south european problems.

  • Kostas Kalevras

    Some recent stats from Spain: Non performing loans rose to 6,5% in May (117,6 billion €), while house prices fell 5,1% in the second quarter. So things don’t really look well there.

    As for ECB it’s really crazy that their Securities Market Programme is on a hold at 74,2 billion € while spreads are just rocketing. I don’t see any other way out than ECB buying securities in the secondary market and then selling them back (at purchase price) to the corresponding nations for a ‘market driven haircut’. That would lower the debt burden and give the markets a hard lesson.

    The Eurobond will happen sooner or later, it seems that we need to get rid of Merkel and Trichet first for that to happen.

  • Dr. Oliver Strebel

    “The Eurobond will happen sooner or later, it seems that we need to get rid of Merkel and Trichet first for that to happen.”

    This can happen immediately and easily: create a southern european currency and issue S-EUR-bonds ;).

  • icebergfinanza

    No Problem …

    Fitch has published an analysis last week on the Italian public finances with a tone not at all alarmed. The analysis by David Riley, Paul Rawkins and Raffaele Carnevale, while recognizing that the mix of low growth and high rates can undermine the reduction of public debt, Fitch notes that the average life and duration of the Italian public debt has been elongated, respectively, and 7.09 years 4.87 years.

    “If spreads were to remain at current very high levels – has been calculated – the full impact of interest on the debt burden would be felt after several years (five ed.) And the debt would fall, however, if the primary surplus targets were be centered with growth unchanged. ”

    Not even a rate of 7% on the year BTP for a long time is a concern for Fitch, considering it “sustainable” in contrast to the calculations of the market would bring the cost of funding by about 4% to 5.5% for 2015 with charges on the debt at an altitude of 110 billion (6.1% of GDP is not far away on the forecasts of the government) against the 75 billion (4.8% of GDP) expected in 2011


  • Andrew P

    Legalities are bunk. They already violated the treaties multiple times. They will do what is necessary to save the system, however late or reluctantly they do it.