Category: Uncategorized

During the weekend before Lehman failed, its general counsel quietly asked outside lawyers to prepare for a filing, just in case. He obviously did it very quietly, as the sheer notion that bankruptcy was even an option being considered would have thrown the whole industry into chaos. At the time feverish negotiations with the government and competitors were taking place and most pundits were expecting a Fed led takeover, a la Bear Stearns. Unfortunately, Sunday night and Monday morning the draft filing was made formal and it was indeed filed on that fateful September, 15 2008.

In the last few days I have started receiving emails and calls about how a euro breakup would play out, from a legal standpoint…which bonds would be repaid in Drachmas or Lire, which in the surviving euro currency, etc. This kind of preparation is the equivalent to calling the bankruptcy lawyers, just in case, except that since the Euro is not controlled by one single entity but by seventeen European governments, the chance of this staying quiet is virtually nil.

The markets now know or speculate that governments, creditors, and debtors have hired top London and New York lawyers to advise them on the legal ramifications of a Euro breakup. This is both a good and a bad thing. It’s bad because the sheer speculation that things are at this point will make markets continue to bet against all non German Issuers; however, it is good as the market knows that when and if that day comes, the logistics would have been worked out before and the panic could be less severe. Is this what the Germans want?

Mario Monti, Italy’s new prime minister was the professor we all wanted to listen to and the one we tried to avoid at exam sessions. He is brilliant and very serious, and paradoxically, the inverse personality type compared to his immediate predecessor, Mr. Berlusconi. The task Mr.Monti has in front of him is also very serious and daunting.

Italy’s problems, and its potential are not new, and the recipes needed to fix them are also generally known to many. The new facts are that, as every trader knows, once you start breaking through historic support levels, coming back up is not going to be easy. An equilibrium was broken and even if the situation were to revert to what it was ex ante, the markets will not return to normalcy until there is either: a. A confirmation of a long period of budgetary prudence that credibly brings debt/GDP ratios towards and eventually below 100%; or b. A bazooka from the European Central Bank (ECB).

This scenario is clearly being confirmed by this week’s market action. After a brief relief rally that didn’t even last a day, markets are edging back to their lows. Given that Monti’s appointment and new government are not going to fix the problem quickly, the attention will shift squarely back to the other Mario, that by one of the ironies of history, is now sitting at the top of the ECB. This is because what Mr. Monti’s government does do immediately, is provide much needed credibility for the other actor who could theoretically solve the problem in half an hour.

Many pundits believe that the tug of war that took place last week was between Draghi and Berlusconi. When in August the ECB started buying Italian BTPs it was on the basis that Berlusconi would deliver on the ECB requests. As Berlusconi dilly dallied, partly because of his own issues, but also due to the Lega Nord’s veto on pension reforms, Draghi who in the meantime was just adjusting his chair to Trichet’s desk, had to play brinksmanship and made it clear to Berlusconi that no reforms meant no more bond buying, or a trickle of purchases. Draghi won that battle and with one veiled threat succeeded in a few days to remove the leader who has faced dozens of prosecutors, courts, and the Italian people many times, and survived.

If this thinking is right, then having won that round, Draghi now needs to face that he got what he asked for. He now needs to pull out his bazooka, which financially today means doing to BTPs (but also possibly soon to OATs) what the Swiss National Bank did to stop Swiss franc speculation; namely, to say that the ECB will not tolerate yields above, say 6%. At this late point in the European debt saga, I am afraid that nothing short of this will work. This decisive ECB action would give Monti and his team the minimum time necessary to deliver on structural reforms, and it would have the added benefit to scare Berlusconi, the League, but also the Left, that if they don’t stay the course, Mario Draghi can also reverse his.