Greek Fire, Part 39

The second I in PIIGS is Italy (Portugal, Ireland, Greece and Spain are the rest) and the Greek Fire that swept Europe over the weekend in the wake of Greek bailout talks falling apart with the reality of a partial default looming has now spread to engulf the Italian economy.  Wary European investors have turned on Italy and are giving the boot-shaped country the boot.

Political soap operas in Italy — especially those featuring Mr. Berlusconi — are nothing new. Nor do they usually matter much to financial markets, even after the debt crisis hit Europe. The widespread problems in Italy’s economy, which has been sluggish for the better part of a decade, also rang few alarm bells.

What’s more, Italy’s banks are sound; they never speculated in a housing bubble. The current annual budget deficit is low, at about 4.6 percent of gross domestic product. And while Italy issues the largest amount of bonds of any euro zone country, Italians own about half the debt, making it less vulnerable to the follies of financial markets.

But with interest rates rising, Italy’s economy is not growing fast enough to cover an accumulated debt load of 120 percent of gross domestic product, the second-highest in Europe, after Greece. The International Monetary Fund expects growth to pick up only slightly, to 1.3 percent in 2012.

In a sign of how quickly things have turned against the country, the stock market regulator imposed emergency rules on Monday against speculation after shares in Italian banks slumped for a fifth consecutive session. The cost of insuring Italy’s sovereign debt against default surged to a record high, and the interest on its 10-year bond leaped to a record 5.67 percent.

While that is still well below what Greece pays, analysts say Italy will have serious problems if its borrowing costs exceed 6 percent.

“Italy is a banana republic that didn’t depend so much on foreign capital in the past, but now it does, and markets are less forgiving,” said Daniel Gros, the director of the Center for European Policy Studies in Brussels. “Italy is in the danger zone; that is quite clear now.” 

Italy has so far avoided the problems that have ravaged Greece, Ireland and Portugal.  But if Italy goes down, the rest of the Eurozone goes with it...and most likely the weakened global economy will be susceptible as well.

Still, if the crisis were to take hold in Italy, the problems for the euro union would dwarf all others to date. European banks have total claims and potential exposures of 998.7 billion euros to Italy, more than six times the 162.4 billion euro exposure they have to Greece, according to Barclays Capital. European banks have 774 billion euros of exposure to Spain and 534 billion euros of exposure to Ireland.

In the United States, banks are also more exposed to Italy than to any other euro zone country, to the tune of 269 billion euros, according to Barclays. American banks’ next biggest exposure is to Spain, with total claims estimated at 179 billion euros.

But at the end of the day, “If Italy goes, it’s no longer a domino,” said Mr. Gros, the analyst in Brussels. “It’s a brick.” 

The Greek bailout falling apart last weekend has now left Italy vulnerable, and should they crack, the dam will be truly burst.  The Greek Fire...it just keeps burning.