Shaky Italy: Berlusconi creates difficulties for the formation of a Monti-government

This was not forseeable this morning, when I wrote my last blogpost. But as far as the support of the Berlusconi-movement (PDL) for a Monti-led government is concerned, have emerged today major difficulties. The outgoing prime minister seems to be oriented to influence directly the names of the new cabinet. If not, he would withdraw his support, sources of the PDL, said this evening. Berlusconi could also propone to President Napolitano a different name than Monti.
The "cavaliere" once again shows with this unacceptable Poker game no sense for the country. He is a power drunken irresponsible. What happens im the markets on Monday, if the new government under the leadership of the highly reaoected Monti will not be formed? For sure a desastrous bloodbath! But this does not interest the crazy man, who behaves like Emperor Nero, who burned Rome and dropped afterwards a tear.
Italy will only be on the safe side, when Berlusconi will be definitely out of politics. The man is pure poison for Italy.     

Don't worry: Monti will save Italy!

As I explained this morning, in Italy the road seems 95% cleared for the formation of a new government under the leadership of Mario Monti, a highly respected academic and economist, who held in two different administrations in Brussels the post of a European commsissioner, first for the Internal Market than for Competition. I see three main reasons, why Monti will save Italy in the next couple of months.
1. Monti is the right man at the right time.
2. He will create a very broad majority in the parliament - a kind of "Great Coalition" - which will provide to the Prime Minister an incredible amount of power, maybe more than any of his ca. 60  predecessors. 
3. He will form a cabinet, that will include the best people. They will come from the two main political sides but there will be also tecnocrats, academics and leaders from respected institutions like the Bank of Italy on board.

Ad 1. Monti is the right man, because he is very smart. He has highest tecnical and ethical standards. He has an incredibly strong and courageous personality - remember his storical fight against Microsoft, that ended with the record fine of 497 Mill Euro and a real victory for the EU. He is visionary and bold. But he is also a affable person, listens very well and is a very good team player. Last but not least he is in the international elite one of the most respected men. He is the best face that Italy has at it's disposal to improve very quickly the terribly damaged image of the country, that has reached in the last weeks scary levels. Nobody here would have ever imagined that Italy would be one day compared to Greece and therefore with the weakest member of the European Union. A shame and a slap in the face for this proud country - founding member of the European Community - that is not only incredibly rich in terms of culture and natural beauties, but also in terms of entrepreneurial spirit, creativity, inventiveness and sense for quality - think about the excellent food and the unicque wines, think of the luxury companies like Armani, Zegna, Versace, Loro Piana...
So Monti will be very quickly very visible on the international stage and I'm sure that he will faster, than many think today, let forget the disastrous past for the country, that Berlusconi with his unacceptable behaviors has been responsible for. In a certain sense is Mario Monti the perfect contrary to Silvio Berlusconi. The world will understand that Berlusconi was not the norm. He didn't represent the Italian-way to be and to do, but he was the exception. And the world will understand that Italy luckily has at it's disposal a broad group of classy people, internationally educated and open minded.

Ad 2. Monday Monti will start working. He will explore the situation on both sides of the political spectrum, in the People of Freedom (PDL) - the Berlusconi movement and the Democratic Party (PD), the left-of the-center party led by the reasonable Pier Luigi Bersani, a former communist, who has turned to a Social Democrat.
The mainstream of the parliamentarians in the Berlusconi party will happily support Monti, because of the alternative scenario, that would prove desastrous: early elections before Christmas. Be sure, that in the aftermath of the utterly flawed crises-management the PDL would suffer a storical defeat. So, the longer Monti stays, the better he can make forget the past, which is in the interest of the PDL leaders. At least today. Elections should be however hold when Monti will have done the bulk of work, expect in March, maybe April.
On the other side of the political arena dominates the word "responsibility for the country". Even if early elections could lead with a high probability to a relative majority of the PD, which could then form a coalition government together with some smaller parties - some on the left side of the spectrum as well as the catholic UDC of the handsome and smart Pier Ferdinando Casini. To be clear: PD-boss Bersani would have a good chance to become Prime Minister in only a few weeks, a dream for every homo politicus. But he shows an admirable attitude, that Berlusconi never had, to put the countries interests before his one. Chapeau! That means: the mainstream of the PD under Bersani will support Monti.
The only party with a significant size, which will not follow the new government will be the regionalist, sometimes secessionist Lega Nord of Umberto Bossi. The long-time ally of Silvio Berlusconi will go happily in the opposition to sharp the profile of his party for the elections 2012 after the desastrous months passed on the benches of the government.

Ad 3. The first rumors of the names for the new governments are very encouraging: 
(a) Gianni Letta, who was crucial during the long tenure of Berlusconi, that the Prime Minister behaved in a constitutional way avoiding even more desasters, should stay as Deputy Prime Minister, covering de facto the role of Chief-of-Staff for Monti. He is a first class civil servant with enormous experience (he is 76)  and he is also a feel-good-factor for Berlusconi, who apparently linked the future of Letta with his dispomibility to resign in reasonable terms. 
(b) The current minister of justice, Nitto Palma, more a legal technician than a real politician should stay as well or should be at least be substituted by a "neutral tecnician". This is also crucial for Berlusconi, because he is obsessed to be persecuted by the justice system. Berlusconi wants to sleep well. And - frankly speaking - I can understand that. 
(c) As successor of Giulio Tremonti at the finance-ministery could arrive Fabrizio Saccomanni, currently General Director of Banca d'Italia, who seemed for some weeks as most likely successor of Mario Draghi as Central Bank Governor. This government department will however change quite strongly his character, because much of the power for economic and financial will be executed in the future by Prime Minister Monti himself. It seemed sometimes in the cabinet of Berlusconi, that Tremonti had more power than his boss.
(d) At the foreign ministery should arrive with Giuliano Amato another member of the meritocratic elite Italy's. He is as former prime minister and multiple minister in different functions; very strong connected internationally. He knows everybody, who counts, and he has the characteristic, that I would call "gravitas" - i.e. seriousness, a natural authority and competence. I was lucky to interview him at the very beginning of my mandate for Handelsblatt, when I arrived 11 years ago as correspondent for Italy.. He was in these times caretaker Prime Minister and he impressed me due to his affable personality and his sharp intelligence.
(e) From the PD side could play a leading roles the expert for social affairs Pietro Ichino as Minister for Welfare and 
(f) Enrico Letta, who was once with 33 the youngest ever Minister in Italy. At the beginning of his 40ies he is still young and could become Deputy Prime Minister in the more political role.
(g) From the catholic UDC will be also included someone, most likely Rocco Buttoglione.

Bottom line: Monti will form a lean and diversified cabinet, which has the perfect mix of politicians of the different parties, that support the government in the Parliament - younger and more experienced -  and technocrats. This government will be highly operative and active. It will move Italy on. If the world doesn't give credit to such a project I do not understand anymore anything! 
Two words to the financial impact: I'm sure that the spread between German Bunds and Italian T-bills should quickly go down from than 500 basis points to 350 maybe. Later this year they could even come down further, if the reforms are well designed. It will be for sure a much more sustainable level than today. The country will be able to refinance itself over the markets in 2012 and will not anymore be forced to be helped out by the bond purchases of the ECB. Italy will prove, that it is not Greece.
Although I'm half Italian, although I live for a long time here, one thing is totally unclear to me: why needs this crazy country always (as in 1992) terrifying crises to move on finally? Crazy country, really!
  

The miracle of Rome

In the last three days something miracolous has happen in Rome: Italian politics has followed a path of reasonableness and appropriatness. The behaviour of the main political actors has become increasingly rational and smart. Sure: Berlusconi went into parliament Tuesday with fully wrong expectations, that his majority would still be there. But his next steps, to go to the President of the Republic, Giorgio Napolitano, and to offer him his resignation was exactly that, what he had to do in democratic and constitutional terms.
Frankly speaking: I didn't expected such an orderly procedure, because of my doubts, that Berlusconi suffered increasingly the "Emperor Nero Syndrom", that means: a lost sense for reality. Well, I was wrong, and I'm more than happy about this misjudgement.
I think however, that such a reasonable handling of the crises was only possible for two reasons:
1. The impeccable political management of the real hero in today's Italy, President Napolitano. With the perfect mix of pressure, moral suasion and concessions he convinced Berlusconi to do the right thing and to free Italy from his legacy
2. The psycological shock for Berlusconi, when he sat on the government-bench in parliament seeing that even his eldest allies were leaving him alone. It can be compared only to the surprise of Julius Caesar, when he asked to his murder Brutus at 15 March of 44 BC, "tu quoque fili?". Berlusconi had been one of most optimistic men on earth. He was used to win, in politics as well as in business and in his private life. Don't forget, that he created with creativity, also ability, a bit of luck and a lots of corruption out of nothing  one of the most precious media-conglomerate in Europe. For many years Berlusconi was not only the most powerful but also the wealthiest man of the country. He had never expected such an end.
So what's next: After the latest developments I do expect, that this weekend the two chambers of the parliament will have passed the Stability Law, which is more or less the transcript into law of Berlusconis letter to Brussels with a series of commitments, like the increase of the pension age and the liberalization of certain professions. The law is not bad, but it has substantially only the function, to be the very last action of this government. The approval is not in doubt and suddenly after Berkusconi will go to the President to resign officially from the post of Prime Minister. After that, Napolitano will meet with Mario Monti and mandate him to form a new government of National Unity.
 I will explain in my next Blog post, that I will post in the next couple of hours, why Mario Monti will succeed in  forming a very good governement, how he will assure a very solid majority on the parliament and what will be the next steps. With other words: how Monti will save Italy. Stay tuned!

European deal risks on many unclear details

Whoever analyses the outcome the European summit, that terminated at 4:30 this night, struggles with a clear valuation.
Sure, all three chapters that had to be adressed, were adressed: orderly default of Greece, fresh capital for banks and the strengthening of the firepower of the EFRS. The problem is not even, that the expectations on the single dossiers were disappointed, no that's not the point, because a 50% headcut on Greece's debt, 108 Bill. of cap hike for the leading 70 European banks and the strengthening of the EFSF to 1 Trillion Euro are impressive figures. I hadn't anymore expected that, overall from the German side.
The issue is about lack of details and the unclear implementation. In management terms you call that execution risks.
While Greece is the most concrete dossier with remaining uncertainties about the concrete adherence of the bank, the capital strengthening plan seems more nebulous. While the target sum of 9% "highest quality capital" is clear, it remains open, which assets banks can count as capital in that definition. This question had to be answered upfront, in my view.
The most fuzzy thing is however the quadrupling of the EFSF. European leaders didn't even name the final sum because of the many uncertainties. Pundits calculate, that it should be roundabout 1 Trillion Euro, but nobody said that officially. And the mechanisms are vague (insurance solution with the participation of private investor, but how, who, what conditions?)
The impression remains, that the leaders had committed themselves in a political move to the bottomline. How this bottomline will work, has to defined later. This process is very top-down and it is well known, how many risks such a design runs.

Let's talk seriously about bank capital

Making banks more stable and resilient is one of the key questions in the current European crises. It seems, that regulators and policy makers have reached a consensus, that banks generally should prop up their capital base to have bigger buffers against losses at their disposal. While this is generally a comprehensive objective, I do not aggree, that it is one of the most pressing problems in this phase. So I would like to pose two more or less provocative questions:
1. Is the capital base of European banks really too low?
Just remember: before the crises the minimum regulatory capital stood at 4% Core Tier 1 (CT1). Most banks had an equity base of around 6%. Although  this was low, the most prominent failures were caused by a shortage of liquidity, not capital. This was the case at Northern Rock in the UK, IKB in Germany and Lehman Brothers in the US. Same picture two weeks ago at franco-belgian Dexia. Nevertheless capital remained a key focus of the various banking reforms and that was of course also correct. The effect is, that today the average bank has a CT1 of 9%, many arrive even in the double digit area. But nobody seems to take notice of that. 
So Ladies and gentlemen: How much capital would be appropriate? This not a scientific question, but it depends on two factors: the political and the market sentiment. Many politicians would like to make banks so robust, that they cannot fail anymore. In such a scenario banking cannot be anymore a profitable business and should therefore - as a consequence - be socialized. And the markets? If they really see a benefit of higher CT1 ratios can be doubted. If that would be the case the Swiss banks UBS and CS (with CT1 over 15%) would structurally over perform the likes of Deutsche or Barclays, which is not the case. 
2. So - if its not capital - what are the real problems surrounding banks?
The flawed stress tests have shown, what's the key question: it is the reliability of sovereign debt. All banks have more or less large amounts of sovereign debt on their balance sheets. Italian banks have Italian treasuries, French banks bonds of the French government. Most of them have also some sort of troubled peripheral debt, Greek or Portuguese in their books. How much are these holdings worth? It makes a huge huge difference, if these bonds are considered risk free or have to be discounted by - say 50%. No capital base, even the highest, could not withstand in that case. But: on what depends the value of sovereign debt. This is exclusively a political question. If Europe guarantees seriously with all it's firepower for example Italian and Spanish debt, it suddenly becomes risk-free. If not, it should be marked to market, Billions of losses would depress the banks threatening the recovery. I have the feeling, that the governments - overall the German - prefer to talk about banks capital ratios while they should absolutely focus on the question of sovereign debt.

Muddle through the middle

Frankly speaking: I don't understand The Germans anymore. We are heading more and more towards a catastrophic crises, but the in Berlin continues to play it's masochistic game of doing too little too late.
This morning the CDS spreads of France and Belgium reached with 200 respectively 300 basispoints peaks never seen during the Euro era. That means that the cost to insure against a default of these countries has neve been so high. On top France risks now a lowering of it's credit rating outlook from Moody's, which could be the first step to withdraw the country it's AAA rating in the next 12 months or so. What does that all mean?
Whoever thought that the Euro crises would be a isolated regional event of some profligate southern countries like Greece and Portugal, maybe also Italy and Spain, has been proved wrong. The Euro crises is a crises of the whole Euro-zone. Useless to point the finger on certain countries, that behaved wrong in the past. We are in one boat and we have to make sure that this boat will not sink.
When France and Germany announced to postpone their decisions in terms of crises solution mechanisms to this weekend, the hope was nurtured, that they would really start to think big. Yesterday's statements from Ms Merkel and Mr Schäuble said the contrary: don't believe that the crises on Monday will be over. As if this would be a bad news!
Don't take me for naïf. It is clear that the Franco-German tandem cannot fix all the problems, that occured in the last two decades with one announcement.  But they could show the world (and the distrustful markets), that they have really started to understand the dimension of the problem. Apparently they prefer to continue to muddle through the middle.

Bold words are useless without credibility

The tricky thing about communications is, that words should always be consistent with actions. Take the Euro crises. The British Prime Minister David Cameron asks the European leaders to go for a "big bang approach" now. They simply would need a "bazooka" to solve the current crises. Sounds strong, isn't it? 
The problem is, what the hell does this concretely mean. Would an increase of the European Financial Stability Facility (EFSF) from the current 440 Bill. Euro to - say 800 or 1 Trillion - already be a "bazooka"? Or should the increase be even bigger? Not clear. When the EFSF was created the spin doctors of the European leaders called it a "shock-and-awe"-plan. The issue was however that the shock took just a few days to evaporate and awe of the financial markets has never existed. The words were bigger than their meaning. 
This can happen. But it should not happen too often. Because every time the senders of such messages loose a piece of their credibility in the eyes of their recipients. The biggest asset in communications, credibility, disappears quite easily. 
Exactly this is today the problem of Ms Merkel and Mr Sarkozy. Even if they would shoot with the "Bazooka", would anybody believe that this time, after so many others times, this is true? Rebuilding credibility is so much harder than losing it. 
What kind of asset, also in financial terms, real credibility can be, has been brilliantly shown by an institution, that has always been consistent: the SNB, the Swiss National Bank. When it announced some weeks ago to intervene in an "unlimited" way to lower the value of the Swiss Franc, the speculation towards new highs immediately stopped. The markets took the words for granted. It is funny, that despite the bold word "unlimited" the SNB had to spend only little money at the end, because a fight between the Central bank and the markets didn't even start. Consistency is a smart communications strategy. 

Financial Crises 2.0 ante portas

We are definitely back in the dark days of the autumn 2008. That was my strong feeling, when the news about the life-threatening funding and liquidity crises of Dexia broke. The Franco-Belgian bank will be split up now, toxic assets will be put into a "bad bank", the governments have provided a state-guarantee for the lender. But who cares about that? The shares have more or less halved their value. And nobody believes, that Dexia can survive in it's current form.
The real problem is not Dexia. The real problem is, that Dexia represents just the first European bank in this new phase, the Financial Crises 2.0. We are staring in the abyss. Who's next? All banks with a similar model - fund short term, lend medium-long term - are now eyed with extreme mistrust. That was already one of the main reasons for the first round of collapses in 2008/2009,  like Northern Rock and Hypo Real Estate. The fact, that sovereign debt from the periphery plays nowadays more or less the same destabilizing role as CDO's and similar structured credit in the first phase, makes all banks with a portfolio of Greek, Spanish or Italian bonds, like Dexia,  extremely vulnerable. The parallels between October 2008 and October 2011 look embarrassing. 
I'm sure that the Financial Crises 2.0 cannot be resolved simply by propping up the capital of the European banks. That would be only the right method, if capital strength would be the key weakness of the system. But: the equity base today is already far far stronger than it was in 2008. Markets don't take notice of that. No! The real problem once again is funding and liquidity and the underlying issue is the lack of trust in banks and peripheral European sovereign debt. 
Instead of wasting time discussing about the capital of the banks, the Finance Ministers should discuss seriously about leaving the trust crises once for good behind us.       

Draghi won't give Italy a run on his money

In a couple of weeks the Italian Mario Draghi will take over as the third Governor of the European Central Bank ( ECB) replacing the Frenchman Jean-Claude Trichet. As the responsible person for the monetary policy of the Euro-zone he will be one of the most powerful people in the world. Among his key-duties are actions on interest rates and money supply as well as providing liquidity to the banking sector.
 I think we can agree, that today the role of the ECB-President is even more influential than it was before the economic crises. The central bank makes de facto often the job, that the governments of the Euro zone should, but cannot or do not want to do. One example is the multi-billion acquisition programm of sovereign bonds in order to sustain such securities, like Spanish or Italian government bonds. With such steps the ECB mixes in fiscal policy and leaves it's usual territory of monetary policy - controversial but to appreciate in my view,  because pragmatic and without alternatives. 
Not at least for that reason many people in financially sound countries like Germany or the Netherlands were initially against the appointment of an Italian at the helm of the ECB. However after a communications campaign during spring it was clear to everybody, that this ominous Mr Draghi is not the "typical Italian",  if such a figure exists at all...stability driven, hawkish and careful in his approach he looks more like a German than a member of the Club Med. 
What does that mean for his future action? When you read the joint letter, that Draghi and Trichet wrote to Berlusconi seven weeks ago and that was leaked only today to Corriere Della Sera, you'll understand it. In that letter the future ECB-boss holds the pistol on the Italian Prime minister's head telling him in detail, what he has to do now: anticipate the balanced budget to 2013, frontload the bulk of the measures to this year, liberalize the public services etc. This is a formidable paper, because it means that Draghi is leaving the territory of moral suasion and moves towards a pure power play. What is not mentioned in the letter, but clearly laid out by the spirit of the words: or you do this, or you will loose our support. And Berlusconi knows perfectly, that this support consists in massive acquisitions of Italian bonds by the ECB in order to drive down their spread vis-a-vis German bunds. Without this action Italy's public finances would soon run into trouble - and with them also the government itself. 
I expect more of that in the future. Italy will not have an easy game, because an Italian sits at the top of the ECB. On the contrary, because he is an Italian he will think twice before helping out his country with money from the ECB. Berlusconi cannot pin his hopes on Draghi. Good for Europe. Good also for Italy.  

Europe needs more courage

The European Union has two substantial problems, one is fragmentation, the other a lack of courage. Fragmentation makes the political process messy and complex. Different countries in different situations have different interests. It is hard to talk with one voice and to act with one hand in a Union of 27 and a single currency zone of 17 countries.  
A lack of courage makes it on the other hand impossible to address rapidly and effectively a crises. The Greek dossier is now on the table for two years without being resolved. Now the possible default risks to become a  major problem for the survival of the whole Euro zone. European leaders, overall the German chancellor and the French president, have failed to treat the problem properly. The handling was far too timid. Otherwise the crises could not spill over to some of the biggest core countries of the Euro zone, notably Spain and Italy. 
Greece has a public debt of not even 400 Bill. Euro, Spain roughly double and Italy more than four times that amount. Nice difference, isn't it? The figures show, how disastrous a full blown contagion would be. Europe would not be prepared for that.
Up to now the leaders agreed to set up a European financial stability facility of 440 Bill. Euro, that should step in to stabilize weak countries, if it occurs. For Greece the current dimension of this rescue fund seems to be sufficient. Not for Italy and Spain. Their debt piles are far too massive to be handled by the EFSF. So the first thing to do is therefore to beef up these funds by four to five times of todays dimension. It seems to be bold, but there is no choice. Furthermore the fund could be leveraged, if needed, which would prevent money-flows from the member countries. Market participants would soon recognize, that European leaders will not accept a failure of the Euro zone. This would lift most of the pressure and provide air to breath. In that scenario I'm quite sure that the fund would not even be used.  
As a second step European banks should be recapitalized in oder to end the speculations of bank defaults. The balance sheets of the banks are full of sovereign debt, Italian banks have mostly Italian bonds, Spanish banks spanish bonds and Greek banks greek bonds. As long as markets valued this sovereign debt as risk free it didn't represent a problem, now that the markets calculate with a probability of sovereign default it has become a major issue overall for the bank of the crises countries. There is no way out, the capital of these institutions have to be strengthened, if possible through the markets, if necessary with public money. A bank default would cost far more than the amount of money, that should be now injected into the system, overall because it is not thrown in a dust bin. The government would simply buy a stake of the system, that could be sold in the next couple of years, maybe even with profit. 
Beefing up the EFSF means to stop the market rout, strengthening the banks capital base means providing the financial system with stability and calm the nerves. The debt crises could be ended in that way. 
Europe needs to act quickly. The alternative is not acceptable. The Euro zone would be destroyed and a prolonged, severe economic crises would follow. In such a gloom-and-doom-scenario the social and political effects for the continent are totally unclear.  
Do the European leaders have enough courage to do the right thing?