The perception of investors against the euro

Je n’ai pris que quelques extraits de l’article démontrant que les investisseurs ont changé d’attitude sur les bonds européens.

Extrait de: It's not about Berlusconi, G.I., The Economist, Nov 11th 2011

What changed is not Italy’s political or economic fundamentals but how investors perceive Italian debt.

For most of the euro era, investors considered euro-zone sovereign bonds to be risk free. Prices and yields would fluctuate but anyone who held an Italian bond to maturity assumed they would get back 100 cents on the dollar (or euro), as they would for a US Treasury or British gilt. This was always something of an illusion.

Risk-free can only apply to the debt of country
that controls the currency in which it borrows.

A holder of its bond knows he can always sell it to someone else, in the last resort the central bank. As Chris Sims of Princeton points out, such bonds may have inflation risk but not counterparty risk.

That has never been true of a euro-zone member country, but investors happily ignored the fact, thanks in part to the European Central Bank which treated all sovereign bonds equally in its refinancing operations.

It no longer can. Investors who once classified their sovereign bonds as risk free must now treat them the way they might a bond issued by a railway company or an electric utility (i.e. as “credit”) and have concluded they own too much.

A staggering amount of debt must now migrate from the portfolios of investors who want only risk-free debt to those of investors comfortable treating it as credit. That is why yields on Greek, Portuguese and now Italian bonds have shown only fleeting responses to multiple bail-outs, austerity programmes and rounds of buying by the European Central Bank. Investors have treated the dip in yields that follow each announcement as an opportunity to lighten up.

In the case of Greece, the volume of debt is small enough to find a new home on the balance-sheets of the official sector (the ECB and eventually the European Financial Stability Facility). Italy is an entirely different matter. People often comfort themselves by saying Italy owes most of its debt to Italians. But according to Bank of Italy statistics (thanks to Fabrizio Goria for the pointer), non-residents held 43% of the country’s €1.9 trillion of debt as of June. That’s a staggering €820 trillion of securities, or $1.1 trillion, and it is being sold.

Reuters reports this morning:

European banks are planning to dump more of the 300 billion euros they own in Italian government debt, as they seek to pre-empt a worsening of the region's debt crisis and avoid crippling write downs…Still reeling from heavy losses on money they lent to Greece, lenders are keen not to make the same mistake twice. Then, under the pressure of governments and a hope that credit default swaps would protect them against heavy losses, they held on until it was too late to sell. With the ECB providing a bid for Italian bonds that might not otherwise exist, board members at some of Europe's largest bank say now is the time to accelerate disposals.

Mohamed El-Erian of Pimco recently noted:

It has become fashionable not only to sell Italian bonds but also to tell the world about it, as loudly as you can. In the last few days several banks have rushed to announce that they have been actively reducing their holdings of Italian debt—as a means of reducing market concerns about their own well-being. This phenomenon is similar to the 1980s phase of “macho provisioning” that saw banks trying to outdo each other in telling the world that they were fully protected against their past loans to Latin America. The result today is to encourage and push other Italian creditors to also sell, adding to the market pressures. In too many cases, the damage to the demand for Italian bonds is much more than transitory.

It is hard to know what Italy can do to change this dynamic. Mr Berlusconi's exit will help, but the focus on him as the cause of the crisis is misplaced: he mattered only insofar as the rest of Europe makes the structural reforms and austerity that he had failed to carry out a condition for bail-out. His departure does not guarantee that a bail-out, if needed, will be forthcoming, much less that it would work. True, Italy’s new borrowing needs are small, given its modest deficit. But its refinancing needs are massive.

According to Bloomberg, it must “refinance about 200 billion euros of maturing bonds next year and more than 100 billion euros of bills,” a sum that would virtually exhaust the EFSF.