Why Italy Matters
Board: Macro Economics
This may have been mentioned here, but I haven't seen it:
- The Italian bond yields have been rising like crazy in large part because the Italy bond market clearinghouse LCH.Clearnet said its members would have to post much higher margins against their holdings of Italian bonds.
This occurred on Nov 9th.
After this "margin call" required banks or individuals trading Italian bonds to either sell a large percentage, or come up with billions of dollars of money.
If you haven't been following the other markets- whenever a margin requirement is raised, typically the underlying asset loses a lot of value quickly.
The problem in this case is the underlying asset is a sovereign bond. When a sovereign bond loses value quickly, its yield jumps, and then the government itself is forced to sell bonds into an environment where they may not be able to afford it
This is different than a margin being raised on most other assets- where the only effect is to wipe out leveraged long players. This has the capacity to wipe out the "leveraged long player" of the country itself.
The Italian bond market has settled down, but it is unlikely (at least to the economist) that the margin will be brought back to older levels.
As risks increase, margin requirements increase.
This happened to both Portuguese and Irish bonds (last year Ireland and in April Portugal) and in both of these cases the bond yields continued on an upwards trajectory.
This means in plain English- the Italians may be effed regardless of what technocrat they put in charge.
The frenzy is not just about their ability to pay (and austerity), but also (more about) the margin requirements on the bonds themselves.
The moral of this is that the risk in the market is much much higher than just the risk of political processes coming into alignment.