Posted by Yves Smith* – Naked Capitalism
Italian politics are messy even at the best of times. The battle over forming a government took a nasty turn. We’ll give a short overview and then make a few observations, in the hopes of eliciting informed reader input.
The far-right Lega Nord, or League party, which won in the wealthy north, was seeking to form a coalition with 5 Star, which led the polls in the South. One of the things they agreed on is opposition to the Eurozone, so that looked likely to feature even more prominently in any joint policies than it had in their respective campaigns.
The coalition had proposed seating Paolo Savona, a very vocal critic of the Eurozone, as finance minister. The president, Sergio Mattarella, nixed the appointment, which he has the power to do. The coalition’s proposed prime minister, Giuseppe Conte, abandoned his efforts to form a government.
Mattarella has proposed that Carlo Cottarelli, a former IMF official, form what amounts to a caretaker government, with his key task to get a budget passed, which would have the convenient effect of calming down Mr. Market for a while. Italian bond spreads are at their highest premium to German bunds in four years.
However, Lega Nord and 5 Star supporters are not surprisingly up in arms, so the current conventional wisdom is that there will be snap elections in the fall instead. Mattarella was seeking to appease the bond gods. From the Financial Times:
Mr Mattarella, who has the power to approve or block cabinet appointments, considered Mr Savona a threat to Italy’s position in the eurozone, at a time when Italian debt was already taking a big hit in the markets.
“The uncertainty over our position in the euro alarmed Italian and foreign investors who invested in shares and companies,” Mr Mattarella said. “The rise in the [bond] spread increases the debt and reduces the opportunity to spend on social measures. It burns companies’ resources and savings and foreshadows risks for families and Italian citizens.”
Unfortunately, that didn’t work as planned. Mr. Market at first liked the idea, with both the Euro and Italian bond prices rising, but then went into full reverse when they saw the severity of the political backlash.
Note that despite Savona, the proposed economics minister, having a fabulously acid tongue, he had said he would uphold Eurozone rules. So was the issue that Savona was seen as such a fierce opponent to the Euro that he’s renege on his promise or that he could be still be plenty disruptive while not crossing any official lines?
The flip side, as Politco snarked in its daily e-mail:
All the fuss, remember, because the president of the Republic rejected one minister (and this is not the first time that has happened) — who seems to have been so crucial to the whole project that without him, it’s better not to govern at all. Even though the caretaker Cottarelli does not on paper have the votes to secure a majority, it’s premature to rule that out. Remember there are other factors that come into play….like looking responsible, particularly when Italian banks are still mighty wobbly, and not wanting to have to campaign again, particularly for any representatives who won with less than comfortable majorities. Twitter Ads info and privacy This is not a constitutional crisis. This is a very bitter, high stakes political crisis, but there are not yet any constitutional issues in play, despite 5 Star calling for Mattarella to be impeached. The underlying issue is austerity and budget constraints. Italy’s economic distress comes from having its GDP contract over the last decade. It needs deficit spending. Eurozone budget rules severely constrain running fiscal deficits.
The worst is the Eurocrats should know better by now. Even the chief economist of the IMF, Olivier Blanchard, said his own data showed that for weak economies, fiscal multipliers were greater than one. That is economist-speak for deficit spending results in even greater economic growth, so that the end result is that debt to GDP ratios fall.
Similarly, Yanis Varoufakis proposed a finesse during the 2015 Greek debt negotiations, a European infrastructure bank. The reason for focusing on infrastructure is it provides for even more fiscal bang for the buck, potentially $3 of GDP growth for every dollar spent. However, colleagues who believe that the Eurozone needs to relax its budget rules said the infrastructure bank idea would run afoul of them as currently constituted. Predictably, Germany nixed the idea. A fall vote as a de facto vote on the Eurozone….or not? The press has been quick to seize on the notion of an election in the autumn as a vote on the Euro. But it isn’t so clear cut, and the two leading parties may not play that up as much as one might anticipate despite that being their biggest area of common ground.
Recall that in Greece, which has suffered far more under austerity that Italy has, in 2015, the Greeks wanted relief but did not want to leave the Eurozone. It was only some time after Syriza knuckled under to the Troika, that Greek votes turned against the Eurozone.
Italian polls show majority support for staying in the Euro. Like Greece, they want to remain but to have more room to spend. So making Eurozone exit, as opposed to Eurozone reform, the campaign pitch might backfire, and Lega Nord and 5 Star pols have to know that. So until we have the government fall and see how Lega Nord and 5 Star position themselves, it’s too early to say how the campaigns will address the Eurozone choke chain. Financial time moves faster than political time and may affect outcomes. Italy has been in the throes of a slow-motion banking crisis since mid-2016. The fall in Italian bond prices will put weak institutions under even more pressure. From a Don Quijones post yesterday:
A recent study by the Bank for International Settlements shows Italian government debt represents nearly 20% of Italian banks’ assets — one of the highest levels in the world. In total there are ten banks with Italian sovereign-debt holdings that represent over 100% of their tier-1 capital (which is used to measure bank solvency), according to research by Eric Dor, the director of Economic Studies at IESEG School of Management.
The list includes Italy’s two largest lenders, Unicredit and Intesa Sanpaolo, whose exposure to Italian government bonds represent the equivalent of 145% of their tier-1 capital. Also listed are Italy’s third largest bank, Banco BPM (327%), Monte dei Paschi di Siena (206%), BPER Banca (176%) and Banca Carige (151%).
In other words, despite years of the ECB’s multi-trillion euro QE program, which is scheduled to come to an end soon, the so-called “Doom Loop” is still very much alive and kicking in Italy. The doom loop is when weakening government bonds threaten to topple the banks that own the bonds, and in turn, the banks start offloading them, which causes these bonds to fall further, thus pushing the government to the brink.
Quijones pointed out that French and Spanish banks are big holders of Italian debt too. So too much Italian political stress could morph into financial freakout. Contagion, anyone?
I suspect it did not go unnoticed that European officials were just about as unhelpful as they possibly could be when Italy was pressing for a waiver from its budget rules so it could rescue its banks. In other words, we’ll see soon enough how committed the upstart parties are to their principles when following through with them could produce a banking crisis. May 29, 2018
————————— *Yves Smith is the pen name of Susan Webber, the principal of Aurora Advisors Incorporated and author of the site ECONned, launched in December 2006. She focused on finance and economic news and analysis, with an emphasis on legal and ethical issues of the banking industry and the mortgage foreclosure process, the worldwide effects of the banking crisis of 2008, the 2007–2012 global financial crisis, and its aftermath. ———————- Annex: The Guardian view on Italy’s political standoff: time for a fresh election Editorial
Italian political parties and voters need to focus on their relations with the EU. But this is a debate for all Europeans too
Italy’s chances of extricating itself from a deepening political crisis were already looking bad when talks about government formation dragged on through April into May. But those chances now suddenly look thin to vanishing. In March’s general election, economic insecurity, immigration and dissatisfaction with the governing class were the dominant issues. Italian voters split into three main groups: the right led by the anti-migrant League, the anti-establishment populist Five Star movement, and a smaller centre-left. None had a majority. The first two eventually managed to cobble together an agenda for government which included both a large tax cut and a large handout to poor families, handing the prime ministership to a political neophyte, Giuseppe Conte, whom both sides clearly hoped to manipulate.
However, at the weekend things got far more tangled. Italy’s president Sergio Mattarella – whose role is more than just that of a formal figurehead – provocatively refused to accept Mr Conte’s finance minister, Paolo Savona. He did so on the grounds that the appointment would threaten Italy’s economy and families’ savings, after the bond market reacted with alarm to the borrowing implications of the government-in-waiting’s spending plans. These, he claimed, could provoke Italy’s exit from the eurozone, which, in European law, could become Italy’s exit from the European Union altogether.
President Mattarella’s refusal to accept an elected government is a dangerous gamble. It ignores the anxieties that produced March’s election result and raises the stakes for Italy and Europe. Five Star reacted by demanding the president’s impeachment. The League called for fresh elections. This now seems the more likely outcome after Mr Mattarella on Monday appointed an economist, Carlo Cottarelli, to head an interim unelected government. Fresh elections are the right course. Nevertheless, they will take place in the full knowledge that the voters could easily call the president’s bluff by returning the two dominant coalition parties even more emphatically than in March. A new election, moreover, would be dominated by the question of Italy’s place in Europe. There is a real possibility that a new rightwing populist coalition government would take power with a mandate to confront the EU and its institutions.
If that happens, the crisis could be far more serious than Brexit for the EU. Britain was always a one-foot-in-one-foot-out member of the EU. It did not join the single currency. Euroscepticism and integrationist caution have long been deep-woven into British politics in almost all parties. Italy, by contrast, was a jump-straight-in-with-both-feet member of the EU. It was a founder member of the eurozone. The rhetoric of Italian civil society was traditionally pro-European, even when Italy flagrantly ignored EU rules and directives that it found inconvenient, as it did with the single currency. As an integral political insider and a large eurozone economy, Italy therefore possesses a far greater potential to destabilise the European project than the always more semi-detached Britain.
The very different revolts in Britain and Italy concerning the EU illuminate the difficulty of establishing a multi-speed European project in the face of integrationist momentum dominated by Germany and France. The creation of the eurozone, especially the austere budgetary rules that were set from the outset at German instigation, and the continuing pressures for ever greater political integration, lie behind both revolts.
One of the many tragedies of Brexit is that, by leaving, Britain has weakened the idea that different speeds and levels of integration should be compatible with the cooperative European project – an idea of which Britain was always the most important proponent. The crisis in Italy threatens to damage the EU more profoundly than might be the case under a more loosely knit Europe. The risks to the overly rigid EU project have seldom been more serious. This requires the frank discussion we advocated last week over Brexit. A confrontational approach towards Italy would be disastrous.
This article was amended on 29 May 2018 to remove a sentence that described Sergio Mattarella as a “centre-right politician”.