My Mortgage Blog

Generally given to witty understatement, London’s The Economist nonetheless had this to say about the latest incarnation of the European debt crisis, which now revolves around Italy. Looking at the worrisome rise in Italian Bond yields, the newsweekly exclaimed:

“At stake is not just the Italian economy, but Spain, Portugal, Ireland, the euro, the European Union’s single market, the global banking system, the world economy, and pretty much anything else you can think of…. Italy matters so much more [than Greece] because it is so vast.”

What should we be watching for in Europe as we focus on the possibility that the continent could send the world into financial chaos? Here’s the bad news: We—and the markets of the world—need some reassurances that European politicians will at long last rise to the moment, thinking boldly, acting wisely. How likely does that seem, given the recent record?

The concerns grew at a rapid pace on November 9, when Italy’s 10-year notes lost their footing and worried investors suddenly demanded a 7.5% return if they were to buy the securities. This is not hard to follow. If fewer and fewer investors are willing to spring for Italy’s debt, the interest rate yield on that debt rises to the point where investors feel they have a deal.

Italy, meanwhile, suddenly has a lot more interest expense attached to its new debt than it was counting on and a salient question arises: Can Italy afford to make the necessary payments on its debt if it bears a much higher interest rate? At some point, the answer could easily become “No.”

Helping it in that direction is another simple question: Will investors continue to finance the debt? That is, when the payment with higher interest becomes due, will investors buy the securities with which Italy makes the payments on its debt? Maybe. Maybe not.

What if Italy can’t cobble the money together to make its debt payments? We’ve watched Greece deal with this one. It is a mad rush for more debt from which to pay down existing debt, and mad rushes tend to result in higher interest rates on the debt.

We can grouse all day about what a self-indulgent leader Berlusconi was, but Italy’s debt position really isn’t that much worse than our own or Britain’s. Further, it has the benefit of a relatively low exposure to creditors outside its own borders. But it is in a monetary/economic system that covers all of Europe. And that means Italy’s bonds are subject to the whims of the overall market and errors of its politicians.

The solution? Better leaders, perhaps. A clearly improving economy, definitely. But the likelihood that the Italian economy will improve meaningfully is small, especially if it tries to get the economy moving primarily from economic activity that doesn’t include a healthy jump in trade with other countries.

I try to follow the meanderings of this international debt crisis and often come away thinking that we may see the bottom fall out of international bond markets any day now. The reality, though, is that we already have seen days where both bond and stock markets fell dramatically, declines that were perhaps stopped—just barely?—by the bond buying of the ECB.

It is possible that this dangerous misery will continue for many months—indeed, it remains possible that we will all grow out of the mess we’ve all created—or it could be that we’ll see a crash in just a few days. It is, in any case, a time to act with great caution. I have rarely looked so deeply into the raging belly of a tornado as its furor continues to form.

The silver lining here is that the real estate sector could continue to move toward improvement, loosening its dependency on international money markets. But that’s a pretty uncertain bet, too. Still…we can hope. And will!