The Italian Job

I am reposting a comment from the pages of the Guardian about the Euro crisis.  What ever the political shenanigans that are going on, this goes some way to explain why Italy was in such a mess for a few days when in fact its borrowings as a percentage of GDP were lower than historical averages.  In addition, it is worth remembering that Italy has a substantial unofficial (euphemism for "black") economy which distorts that ratio, and the Italian public are not highly geared and are in fact substantial savers.

Six weeks ago the UK government took the unprecedented step of launching a legal challenge against an ECB move to make all clearing operations in euro-denominated instruments above a certain volume take place in the Eurozone under central bank supervision.


Most such operations currently take place in London, and on Thursday morning, the main London clearing-house LCH suddenly doubled the margin or collateral requirements on trade in 7-10 year Italian bonds, carefully timing the move to drive 10-year yields above the key 7% level, triggering a derivative avalanche that quickly took yields to unsustainable levels, while City economists appeared all over British TV announcing the end of the Euro.

This followed up the previous week's attack which had opened a breach or beach-head in the Eurozone at its weakest point, in Greece.

The main weapon in the ongoing 2-year war between the US-UK financial 'Allies' and the key Eurozone axis of Germany-Italy is the credit insurance or CDS which is taken as the market pricing of risk attaching to debt. London clears most Eurozone CDS, and when LCH (jointly owned by City traders) opened the attack on Italy, speculators holding no Italian bonds started buying insurance policies on Italian debt they didn't own but hoped to destroy ('naked CDS'), driving up the market measure of default risk on Italian bonds, and thereby further driving down the prices of the now supposedly 'riskier' bonds (which prices automatically factor in the market pricing of risk), and driving up the yield, which in turn, once above the 7% level, further drove up the price of Italian soveriegn CDS in a sort of virtuous speculative circle.

A coordinated derivatives attack, by the very people who will lose out if they don't destroy the Euro and ECB first, can move the prices and yields of the bonds the derivatives are nominally hedging much more than direct shorting of the bonds themselves (especially in the case of Italian debt where there's a huge market and great liquidity).

Eurozone leaders, led by Germany, have tried to ban such 'naked CDS', starting with a joint proposal from Merkel and Sarkozy to the European Commission in March 2010. But London has consistently resisted such regulation, repreatedly deferring even discussion, first delayed to July 2010, and since repeatedly delayed until at least July 2012 - by which time some people in the City think the battle will be over anyway.

Of course, the people who pay for this vicious cycle of unregulated (and untaxed - another battle) speculative asset-stripping, as the London-NY bearpack attacks the threatening Euro and Eurozone regulation, are the ordinary people of the Eurozone and of Europe more generally.

One can only hope that the experienced Italian trader Draghi at some carefully-timed point in the near future turns the tables on the feral speculators of the City and Wall St by suddenly announcing that the ECB will underwrite Eurozone sovereign debt.

It would be interesting to see if the UK government, on behalf of the City, then tried to contest the move as contravening the Lisbon Treaty they so despise.

Perhaps not, because a successful speculative attack on the Club Med would probably bring down a few of the UK banks that haven't fully insured their collective Club Med exposure of about ₤350bn.