Italy Bonds Push Higher

Is the endgame near for Italy?

Interest rates on Italian bonds rose to new euro-era records on Monday, close to the
level that earlier forced Greece, Ireland and Portugal to seek financial rescues.
Bond rates are being driven by investors’ doubts that Prime Minister Silvio Berlusconi
can push through sweeping changes in Italy, encompassing everything from pensions to
privatizations, seen as necessary to tackle its heavy debt load and revive its stagnating
economy.
Investors are also selling Italian bonds because they fear a lack of solidarity among
other European countries to provide billions of euros in support to Italy if conditions get really
bad.
They worry that European leaders have not come up with sufficient details about an
expanded bailout fund, which is meant to provide massive firepower for Italy and other
countries such as Spain should the markets turn against them.
“Euro zone policy makers have yet to announce a policy bazooka,” said Jens Nordvig,
an economist at Nomura Holdings in New York, in a research note. He said the structure of
the purported $1.4 trillion bailout fund, announced at a meeting of European leaders in
Brussels last month, “is insufficient to provide a credible backstop.”
The yields on Italy’s 10-year bonds, a measure of investor anxiety about lending money
to Italy, rose to 6.63 percent at one point during trading on Monday.
But yields later fell back slightly, apparently as rumors spread through the markets that
Mr. Berlusconi was intending to step down.
Mr. Berlusconi denied the speculation. Yet the markets seem to be saying that they
would be happier about Italy’s future if he were to relinquish power.
“The government needs to do a lot more to gain the full confidence of the Italian
people, external creditors and the markets,” said Mohamed El-Erian, chief executive of the
bond giant Pimco.
The higher interest rates are adding to Italy’s debt problems. Its next auction of debt is
on Nov. 14. It has to raise 30.5 billion euros in November, and a further 22.5 billion euros in
December, according to Daiwa Securities.

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 When its interest rates were just above 6 percent, the extra bond yields were already
adding as much as 3 billion euros in additional interest payments annually compared to the
rate of about 4.5 percent it was paying as recently as the summer, Daiwa estimated.
Now those debt costs are rising with every basis point increase in bond yields.
At the same time, the higher interest rates are slowing economic growth, and making it
ever harder for Italy to generate tax revenue to meet its debt payments.
It is a worrying spiral that, before Italy, hit Greece, Ireland and Portugal. When their
rates reached around 7 percent, they suddenly jumped higher and have still not come back
down to more-sustainable levels.
Italy, the euro zone’s third largest economy after Germany and France, is on a different
scale to those much-smaller nations.
Analysts are not yet saying that Italy will be forced to seek assistance from the
European Union or the International Monetary Fund, as these countries did before them.
Before that happens, many expect the rising rates will force the European Central Bank
to step up its purchases of Italian debt in secondary markets, which began in August. So far,
however, the E.C.B.’s program of bond purchases has failed to keep Italian interest rates
down, and they expect the central bank will have to act more aggressively.
Analysts also think the market turmoil will force European leaders to act more quickly
to provide exact details on how they plan to pay for the $1.4 trillion European Financial
Stability Facility. Only then will the bond yields, and market pressure, subside, they said.

ITALY GOVERNMENT BORROWING RATES HIT EURO-ERA HIGH

The Italian government's borrowing cost has risen as fears grow over political
uncertainty in Rome.
The yield on Italian 10-year bonds rose from 6.37% to a euro-era high of 6.64%, before
retreating to 6.5%.
It is feared that Italy, the eurozone's third biggest economy, could become the next
victim of the debt crisis. PM Silvio Berlusconi faces a crunch vote on public finance on
Tuesday.
Mr Berlusconi denied on Facebook reports that he was about to resign.
Stock markets across Europe bounced up on the chance of the Italian premier's
departure but returned to negative territory at Monday's close.

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 In London, the FTSE 100 ended down 0.3%, France's Cac 40 fell 0.6%, and in
Frankfurt the Dax index closed down 0.6%. In early afternoon trading in New York, the Dow
Jones industrial average was down 0.76%.
Concerns over Italy are overshadowing developments in Greece, where Prime Minister
George Papandreou has agreed to stand down.
Mr Papandreou sealed a deal with the opposition to form a new coalition government to
approve an EU-IMF bailout package.
Once the vote has been passed, it will open the way for Greece to receive the next 8bn
euro tranche of bailout loans.
The deal was welcomed by investors, with the main Athens bourse up 1.4%, lifted by
the banking sector. Shares in Alpha Bank were up 6.8% while Hellenic Postbank rose 8.9%.

Beginning of the end'

The markets are viewing Italy's ability to repay its debt as increasingly doubtful.
The spread between Italian and German 10-year government bond yields had widened
to 488 basis points in early trading, its widest level since 1995.
The yield on Italian one-year bonds also jumped to 6.3% from 5.5% on Friday, though it
later fell back to 6.1%.
By comparison, the yield on German one-year bonds is 0.26%.
It comes as data on Monday showed the European Central Bank (ECB) more than
doubled its purchases of government bonds in the first week of Mario Draghi's presidency.
Purchases totalled to 9.52bn euros, compared with the previous week's 4bn euros and
was the most the bank has spent since mid-September.
Richard Hunter, head of equities at Hargreaves Lansdown stockbrokers in London, said
the worries over Italy were not so much about the economy but about the state of the political
situation.
"This may be the beginning of the end for Berlusconi," he told the BBC.
"We're talking about a completely different animal when it comes to Italy [compared
with Greece].
"Greece is responsible for 2% of [the eurozone's] GDP whereas Italy is the third biggest
economy behind Germany and France."
Pressure is growing on Mr Berlusconi, with the opposition also preparing a vote which
is being seen as one of no confidence in the prime minister.

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 BERLUSCONI BURLESQUE

FIRST Greece. Next Italy? Troubled euro-zone countries get bail-out money with
conditions and strict monitoring by the International Monetary Fund (IMF). But at the G20
summit that concluded in Cannes today, the troubled euro zone got no more money (more on
this in my next post), and Italy was placed under IMF monitoring.
Though yields on its bonds have soared alarmingly, Italy has not had to seek a bail-out
(not yet anyway). And in an attempt to ensure it does not succumb, bringing down the euro
with it, it has been placed under a special preventive regime—placed on probation to ensure it
implements the many promises it made to carry out reforms designed to promote growth and
balance the budget by 2013.
The polite fiction is that Italy has "invited" this monitoring, but nobody makes any
secret of the fact that the government of Silvio Berlusconi has a problem with “credibility”.
Nicolas Sarkozy, the French president, says Italy’s case is “completely different” to that of
Greece, which has galvanised the attention of the G20 summit, given the prospect that it may
soon default on its debt (see my recent post here and my last column here)
By the same token, Italy’s position is now markedly worse than that of Spain, which
until this summer had been seen as the country most likely to succumb after Greece, Ireland
and Portugal. But Spain's outlook is now less dire as a result of a succession of reforms, and
the decision by the prime minister, José Luis Rodríguez Zapatero, to step down at the next
election later this month.
So Mr Berlusconi, in the dying days of his government, has been put in remedial
class—a humiliation for the third-biggest economy in the euro zone, and a founding member
of the European Union. “He is fully aware of the seriousness of the situation. And if he
wasn’t, he is aware of it now,” says one senior EU source.
Little more than a fortnight ago, such treatment would have been unthinkable. Officials
in Brussels recount how Mr Van Rompuy had sent Mr Berlusconi an early draft of the last
European summit’s conclusions, making passing reference to “specific commitments made by
Italy and Spain”.
Mr Berlusconi telephoned him, saying being singled out in such a manner was “a
scandal”. Italy’s fiscal position, with a primary budget surplus (before interest) and low
private debt, was healthier than that of most other euro-zone members, insisted Mr
Berlusconi. Italy’s high debt was the product of the past, accumulated by previous Christian

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Democrat and Socialist governments for which he could not be held accountable. “I have
always wanted to carry out reforms,” Mr Berlusconi told Mr Van Rompuy. To which the
European Council president replied: “Silvio, it's time to make your dreams come true.”
At the first of two pairs of European summits last month, Mr Berlusconi was summoned
by Angela Merkel, Germany’s chancellor, and Nicolas Sarkozy, the French president, to be
told to come up with a credible reform plan within three days (see my column here), in time
for the second round of summits on October 26th.
Euro-zone leaders welcomed Italy's promises but, as with cold-war nuclear pacts,
decided to “trust but verify”. The summit declared:
“We invite the Commission to provide a detailed assessment of the measures and to
monitor their implementation, and the Italian authorities to provide in a timely way all the
information necessary for such an assessment.”
A week later, the IMF was also “invited” to join the monitoring process. As well as
humbling Mr Berlusconi, the decision was also a sign of mistrust in the ability of the
commission to act with sufficient rigour.
Mr Berlusconi shrugged it all off as nothing more that an audit, of the sort that a
company might seek from an accountancy firm. Some audit. Christine Lagarde, the IMF's
boss, said she would be reporting quarterly, in public documents, on Italy’s progress. This is
what she had to say:
“We will be checking the implementation of the commitments that have been made by
Italy under the 15-page commitment that it has made to the members of the euro zone a
couple of weeks ago. So it’s verification and certification, if you will, and implementation of
a programme that Italy has committed to. As far as I’m concerned, I might be laborious I
might be demanding, I might be rigorous but I will be looking at the commitments that have
been made to confirm the implementation.
The problem that is at stake, and that is what was clearly identified both by the Italian
authorities and by its partners, is a lack of credibility of the measures that are announced.
Therefore, to attest the credibility of those measures, in other words their implementation, the
typical instrument that we would use is a precautionary credit line. Italy does not need the
funding that is associated with such instruments. The next best instrument is fiscal
monitoring.”
The question of precautionary credit lines led to a strange little incident that highlights
Mr Berlusconi’s problem with credibility. The Italian prime minister claimed that the IMF

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had offered him such a line of credit. But Ms Lagarde said no such offer was made. Who to
believe? Most will take Mrs Lagarde’s word over Mr Berlusconi’s.

FIAT AND ITALY. ARRIVEDERCI, ITALIA?

DUTY, history, and responsibility are what keep Fiat, Italy’s biggest private-sector
employer, based at home. Running counter to such fine notions, said the carmaker’s boss,
Sergio Marchionne, earlier this year, is Fiat’s need to make decisions “rationally”. It has lost
money in Italy for years. It expects things to get worse as sales slump at home. Small wonder
that the country regularly goes into hysteria over whether Fiat will stay.
Its takeover of Chrysler, an American carmaker, is one reason to worry. Fiat (whose
chairman, John Elkann, is a director of The Economist’s parent company) has not decided
whether the combined group’s headquarters will be in Turin or Detroit. That may involve
little more than a plaque on the wall, as the company argues. But Fiat’s manufacturing
presence in Italy is under threat too. Despite earning two-thirds of its revenues abroad, it still
has almost half its employees and 40% of its plants in Italy. Mr Marchionne has repeatedly
threatened to shutter Italian capacity if he cannot make it productive.
On October 20th Consob, Italy’s stockmarket regulator, demanded details of a 2010
plan called Fabbrica Italia, in which Fiat promised to invest €16 billion ($22 billion) in its
Italian plants over four years in return for new agreements on working conditions. As part of
this plan, it is repatriating production of the Panda, a small car, from Poland. But Fiat has also
changed some elements: two prestigious models it was going to bring to its Mirafiori plant in
Turin will be replaced with smaller cars.
Fiat rejected Consob’s demands for more detail on the plan and attacked the regulator
for asking for it publicly. Maurizio Landini, secretary-general of Fiom-Cgil, a metalworkers’
union which has fought hard against Fiat’s new working conditions, says his main fear is that
Fabbrica Italia only exists on paper. He claims that Fiat is basing the development of its most
innovative future projects, such as hybrid and electric cars, in America.
Fiat’s Italian plants are 15-20% less efficient than those of competitors elsewhere in
Europe. Its Polish, Serbian and Turkish plants run at more than 70% of their capacity,
whereas Italian ones run at 33%. (Part of the gap comes from lower productivity, part from
Fiat choosing to make cars elsewhere and part from varying levels of demand). Flexibility has

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been the firm’s main problem. For example, if a car on one production line sold badly and a
model on another line sold well Fiat could not move workers across under the old rules.
The firm’s employees proved this year that they are ready to compete. A majority at
three Italian plants voted to accept new working practices and, apart from Fiom-Cgil, all
unions signed the deal. At a long-shuttered plant near Turin that Fiat has bought from another
carmaker, 89% of the idled workers voted for the changes despite Fiom-Cgil’s strong
presence.
So it can bargain directly with workers at factory level, Fiat has also decided to quit
Confindustria, Italy’s main employers’ lobby, after it offered the unions’ national chiefs a
final say on pay deals. Fiat has thus made two big breaks with Italy’s collective-bargaining
tradition, says Roberto Pedersini, a labour-relations expert. First, it has repudiated industry-
wide, national labour standards. Second, it is taking away labour protections when company-
level agreements usually give more rights to workers. To be rational, Fiat’s Italianità has to be
less dutiful.

ITALY ON THE BRINK

EUROPE'S long-awaited crack at a bold euro-crisis solution calmed markets for all of
two days. After digesting the plan, and observing a dismal Italian bond auction, equities are
dropping today and the sovereign bond yields around the euro-zone periphery are rising. This
development comes as little surprise. The euro zone needed to put together a credible, suitably
large backstop for government debt. Instead, leaders cobbled together a plan to provide a
guarantee against some losses on government debt and to leverage up the European Financial
Stability Facility's paltry €440 billion in capital. But even a leveraged up fund looks small
against the scale of maturing debt, and the enterprise is weakened by reliance on the backing
of peripheral sovereigns which are themselves under threat.
And so attention once again turns to the European Central Bank. As recent Nobel-
winner Christopher Sims explains here, central banks were originally created to manage the
market for their sovereigns' debt. Because central banks can print money, their presence as a
buyer of last resort essentially eliminates the risk of panic. Given fiscal backing, a central
bank can act as lender of last resort without generating the risk of runaway inflation (although
in Europe's present economic situation that's hardly a concern; a spree of unsterilised debt
buying would do the euro zone good). The ECB was deliberately created without fiscal

7
backing and without the right to buy the debt of member governments. It's a pseudo-central
bank, leaving the euro zone with the strictures of a single currency area but without the
critical shock absorber most economies enjoy. Obviously, the ECB has intervened in debt
markets to a limited extent, but its leaders have been unwilling to make the sort of
commitment that might actually end the crisis.
One big concern, both at the creation of the euro and now, is that the promise of ECB
support would eliminate the incentive for member states to mind their fiscal behaviour. If the
pressure of the current crisis were relieved, Italy would lose an incentive to reform its
economy and trim its budgets. That's both correct and largely irrelevant. The long-run
sustainability of the euro zone depends on improving the functioning of its economy as a
single-currency area. A number of peripheral countries face significant problems of
competitiveness that can't be resolved through exchange-rate adjustment. More euro-wide
inflation would help achieve the necessary relative price adjustment, but the ECB has been
stingy with its monetary policy, as well. Absent sensible fiscal consolidation, insolvent
countries will face either prolonged dependence on euro-zone institutions or debt
restructuring.
At the moment, these concerns pale next to the threat of a euro-zone implosion thanks to
the lack of a proper central bank. The rising panic premium threatens to drive half of the
currency area into insolvency. Given the interdependence of the large euro-zone economies,
there is no chance of member nations slashing their way to health; austerity in one nation
reduces the demand available for exporters in another, sinking euro-zone economies in unison
and undermining austerity efforts. Italy has been saddled with a big debt load and a moribund
economy for some time, but for much of the first year of the crisis, markets treated the
country differently than Greece, Ireland, and Portugal, largely because the country chipped
away at its deficit and stabilised its debt in the decade prior to the crisis. In the absence of a
buyer of last resort, however, contagion reigned, dragging Spain, Italy, and Belgium into the
gyre.
Europe's institutions need an overhaul if the euro zone is to function in the years ahead,
but the ECB must act forcefully to be any hope of a future. Responsibility for that will fall to
Mario Draghi, who tomorrow succeeds Jean-Claude Trichet as head of the bank. There's a
clear awkwardness to the hope that an Italian will immediately begin massive purchases of
Italian debt upon assuming control. Certainly Mr Draghi is conscious of the difficulty and the
discomfort it might create among his German colleagues. There are no other good options,
however. He will either save the euro or allow it to fail.

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 HANDS OFF OUR PENSIONI

THIS week Umberto Bossi, leader of the Northern League, the junior partner in Silvio
Berlusconi’s coalition, told a reporter who approached him politely that she was “irritating the
fuck out of” them and should “piss off”. He had a similar message for the euro zone.
On October 23rd, in Brussels for a euro-zone summit, Mr Berlusconi received a ticking-
off from Angela Merkel, Germany’s chancellor, and Nicolas Sarkozy, the French president,
for not doing enough to guarantee the stability of Italy’s public finances (see Charlemagne).
In response he hit on the idea of scrapping a prized facet of his country’s welfare system.
Italians can retire before pensionable age if they have contributed for long enough to the state
welfare system: from 55 (if they have contributed for 40 years) or from 60 (for 36 years).
But Mr Bossi vetoed the plan, hinting that it could tear the government apart. Mr
Berlusconi was left to return to Brussels with a letter that promised much but guaranteed little.
It included pledges to raise the normal retirement age to 67 by 2026 (the previous plan was to
reach 65 by the same date); sell off assets worth €15 billion ($21 billion); and make it easier
for employers to sack workers in a crisis.
Why did Mr Bossi take such a hard line? Local elections in May showed that the
Northern League was suffering almost as much as Mr Berlusconi’s party from the
government’s waning popularity. And Mr Bossi’s leadership of the League is no longer
uncontested. A growing number of followers would like to see him step down in favour of the
younger interior minister, Roberto Maroni.
Successive austerity packages introduced this year have convinced Mr Bossi that the
government should not try to run its full term to 2013. By then, higher taxes and spending
cuts would have made it even more unpopular. As he put it, “It’s hard to fleece people and
then get them to vote for you”.
They might do so, however, if you have defended their right to a long, state-funded
retirement. Since workers tend to start making contributions at a younger age in Italy’s more
industrialised north, early retirement is most prevalent in the League’s heartland. In
Lombardy more than 9% of the population receives a so-called pensione di anzianita. They
will no doubt be feeling quite grateful for Mr Bossi’s bloody-mindedness.

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 THE ITALIAN JOB

FOR months insiders have called it the “Bini Smaghi” problem. It may sound like a
mathematical or chess puzzle (in a way it is: how to get from three to two when the one
doesn’t want to be subtracted), but high European diplomacy is at stake and low political
manoeuvrings are at work. And the problem has just got a lot trickier.
Lorenzo Bini Smaghi is a suave Italian who has been on the executive board of the
European Central Bank (ECB) since June 2005. This means that he has another two years to
go, since each of the six members of this prime piece of monetary estate serves a single eight-
year term. That is why Jean-Claude Trichet, the president of the board and the bank, is about
to step down, his stint having begun in November 2003.
The Frenchman will be replaced by “Super Mario” Draghi who, as governor of the
Bank of Italy, has been on the ECB’s governing council since 2006. (Each of the 17 national
central banks of the euro area has a place on the council, which is thus 23-strong, including
the board members.)
Formally, nationality plays no part in appointments to the board (other than the fact that
members must be from countries in the euro area). Informally, it counts for a great deal. In
particular, there are two unofficial rules: one, big countries like Germany and France
automatically have someone on the board; and two, no one country has more than one person
on the board.
As things stand, both these rules are going to be broken. Italy will have not just Mr
Draghi as president but also Mr Bini Smaghi on the board. France will have no one. The
obvious solution—for Mr Bini Smaghi to replace Mr Draghi at the Bank of Italy, creating
space for a French candidate—has fallen through following an extraordinary day yesterday in
which no fewer than three names were considered for the top central-banking job in Rome.
Silvio Berlusconi, Italy's prime minister, had bowed to French pressure to appoint Mr
Bini Smaghi. But protests in the press, and from the Bank of Italy, led him to backtrack and to
moot, in quick succession, two internal candidates. Ignazio Visco (pictured), deputy director-
general at the Bank of Italy (and a former chief economist at the OECD), now looks set to get
the prize.
That leaves the Bini Smaghi problem looking even harder to solve. In theory Mr Bini
Smaghi can stand his ground, appealing to the sacred principle of ECB independence, which
should mean that he cannot be ousted from the board on political grounds. In reality his

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position is untenable. Having an Italian at the head of the ECB is awkward enough given the
support the central bank is providing Italy by buying its government bonds in the markets.
Having two on the board (and Mr Visco making a third on the council) will give critics of the
ECB a field day.
It is not obvious what the solution will be. Still, finding it may appear a welcome
diversion for European leaders, as they give every impression of serving up a giant-sized
helping of Eurofudge at their moving feast of summits over the next few days. This is a dish
unlikely to satisfy nervous investors and markets, who had hoped for something to calm their
fears rather than to feed them.

“SUPER MARIO” TAKES CHARGE

MARIO DRAGHI of Italy has barely begun his new job: he became president of the
European Central Bank (ECB) on November 1st. But already he is doing things differently
from his French predecessor. Jean-Claude Trichet liked to prepare the ground for interest-rate
changes by signalling them before they were actually decided. In his first meeting chairing the
ECB’s governing council, Mr Draghi broke with that tradition and the council unanimously
decided upon an early cut, reducing the main policy rate from 1.5% to 1.25%.
The decision came as a surprise to financial markets partly because it departed from Mr
Trichet’s way of doing things, but also because Mr Draghi was expected to shy away from
cutting rates in his very first meeting for fear (as an Italian) of being seen as soft on inflation,
especially in Germany. But quite rightly Mr Draghi put that on one side and followed the
economic logic for lowering rates as soon as possible. The euro area, he said, was heading for
“a mild recession” by the end of the year. The slowdown would bear down on price pressures,
and inflation, which is currently running at 3%, would subside to below 2% (in line with the
ECB’s target) in the course of next year.
A further interest-rate cut now looks imminent, almost certainly in December. Mr
Draghi stressed that the ECB’s growth forecasts would be revised down significantly when
they will be published next month. Moreover he stressed that the slowdown had in large
measure sprung from the uncertainties and financial strains generated by the European debt
crisis. The risk of further damage has intensified since George Papandreou, the Greek prime
minister, shocked the markets at the start of this week with his surprise call for a referendum
on the latest rescue package for Greece announced by European leaders on October 27th.

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 Mr Draghi may have struck out in a fresh direction in his conduct of monetary policy,
but he was also keen to emphasise the qualities of “continuity, credibility and consistency”
that he shared with his predecessor. He sought to quell anxieties in Germany about an Italian
at the head of the ECB, expressing his “great admiration” for the tradition of the German
Bundesbank.
Those anxieties are particularly pronounced about the ECB’s government bond-buying
activities through its “Securities Markets Programme” (SMP). That programme, which started
in May 2010 with purchases of Greek debt, was extended to include purchases of Italian and
Spanish debt in early August when their bond yields rose close to unsustainable levels. Mr
Draghi insisted that the SMP was “temporary” and “limited”; and that it was being done only
for monetary purposes (an unconvincing rationale that the ECB has consistently given). Such
external intervention, he said, could not bring rates down sustainably. For that to happen,
governments such as Italy’s had to sort out their public finances and make structural reforms.
Mr Draghi was also asked whether the ECB should act as lender of last resort to
governments. The lack of that backup, some economists now argue, is why the debt crisis has
proved so virulent in the euro area whose 17 national governments can no longer turn to their
central banks (see this week’s Economic Focus). But Mr Draghi rejected the proposition,
saying that this is not in the ECB’s remit, which is to ensure price stability in the medium-
term.
In an assured first appearance, Mr Draghi combined both the new and the old. Through
its ability to create money, the ECB has the power to contain the euro crisis if it flares up into
an even fiercer fire. But under its new president, the central bank is continuing to insist that
European politicians put out the blaze.

ITALY AND THE EURO ZONE. SHALL I KILL HIM?

“I HAVE never failed to make the grade,” says Silvio Berlusconi after being summoned
before headmasters of the euro zone for a beating. “I was convincing.”
But Angela Merkel of Germany and Nicolas Sarkozy of France thought differently.
When asked whether Italy's prime minister had reassured them about doing his homework to
draw up a plan to bring down Italy's vast debt and implement structural reforms, Mrs Merkel

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and Mr Sarkozy first hesitated, then looked at each other and, finally, smirked knowingly.
(video clip here, in French)
“How to put it?” started Mr Sarkozy, “We have confidence in the sense of responsibility
of all of Italy's political, financial and economic authorities.” Mrs Merkel chipped in: “It was
a meeting among friends.”
It was anything but friendly. Rarely has a member of the euro zone—and a founding
member of the European integration project, no less—been chastised so publicly. But in many
ways, the euro-zone debt crisis is now all about Italy.
In discussions all weekend, including at two European summits, leaders worked on
drawing up a package deal to save the euro that should be concluded in another round of
summits on Wednesday.
All three of the main issues—the fate of Greece, the “firewall" to prevent contagion and
the recapitalisation of Europe' banks—revolved in some ways around Italy: if Greece's debt is
restructured, will the markets then turn on Italy, the next most-indebted state in the euro zone?
If so, is the new firewall big enough to protect Italy? And does the plan to strengthen banks
with fresh capital, so that they can withstand the loss of value of their bond holdings, not
place an unfair burden on Italy, whose banks hold vast amounts of depreciated Italian debt?
Earlier this summer, when Italian bonds started to collapse, the European Central Bank
(ECB) had quietly told Mr Berlusconi to push through reforms in exchange for the ECB'
intervention to buy Italian bonds, so holding down Italy's borrowing costs. But once the most
acute market pressure was relieved, Mr Berlusconi began to backtrack on his austerity
measures, to the fury of Germany.
At the summit, Mr Berlusconi was told bluntly to go away and come back in three days'
time with a credible plan to reform his country. “There is no question of appealing for
solidarity from partners if those whom we assist do not themselves make the efforts
necessary” declared Mr Sarkozy.
Herman Van Rompuy, president of the European Council (who presided over the
summits), later repeated the point, saying “certain countries” had to make “commitments”
about future reform. Or else, what? asked journalists. “They WILL make commitments,”
replied Mr Van Rompuy, curtly.
The Italian prime minister, through, is unrepentant. Like every practiced school
miscreant, he has an excuse for everything.

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 No structural reforms? His partners in the Northern League prevented a reform of
pensions. Now he would urge the league's boss, Umberto Bossi, to abide by proposals to have
a uniform retirement age of 67 across the euro zone.
Was Mr Sarkozy not furious with Italy? Well, the French president's attitude to Italy
was coloured by his understandable annoyance about the allocation of seats at the ECB.
Having supported an Italian, Mario Draghi, to succeed Jean-Claude Trichet as the bank's
president, France had demanded that the Italian member of the ECB's six-man executive
board, Lorenzo Bini-Smaghi, should step down early to make way for a Frenchman. But Mr
Bini-Smaghi had declined to listen to pleas to avoid a casus belli between Italy and France,
despite the offer of prestigious jobs back home (though not the job he wanted, ie, to become
governor of the Bank of Italy).
“Sarkozy was annoyed,” admitted Mr Berlusconi. “There has been a clash on this
question of Bini-Smaghi, for which I bear no responsibility. At a certain point I told him
[Sarkozy]: 'What can I do? Shall I kill him? I don't think so.'”
Mr Berlusconi is always great with the one-liners. But his buffoonery is wearing thin on
the rest of the euro zone.

BERLUSCONI'S BUNG

NOTHING illustrates better the gulf between Italy’s multi-billionaire prime minister,
Silvio Berlusconi, and the people that he governs than the impact of Italy’s emergency
budget, introduced on June 30th. For most Italians, it meant sacrifices running to hundreds of
euros. For Mr Berlusconi, it promised savings of hundreds of millions.
In total the cabinet approved deficit-cutting measures of €40 billion ($55 billion). The
finance minister, Giulio Tremonti, wanted to dispel any spectre of a Greek collapse in Italy.
But he is under pressure, especially from Mr Berlusconi’s coalition partners in the Northern
League, to consider the political consequences. Alarmed by the ruling parties’ dismal showing
at local elections in May, the League’s leader, Umberto Bossi, has called for a U-turn: tax cuts
funded by drastic cuts focused on defence spending.
The four-year austerity budget is a compromise. Mr Tremonti got his deficit reductions.
Yet all but €6 billion of the tax rises and spending cuts will take effect after 2012, hinting that

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there may be an election next year, before they bite. Mr Bossi got a promise of lower income
tax, accompanied by a hint that the shortfall may be made good by a gradual rise in VAT.
That would hit the poor harder than the rich. But as the details became known, there was
even worse news for the less well-off, including many of Mr Berlusconi’s (and even more of
Mr Bossi’s) voters: increased health charges and a freeze on cost-of-living increases for
higher-value state pensions. More cuts must be made by local and regional authorities, which
are set to lose €10 billion in central-government transfers. The budget also includes a rise in
the flat-rate stamp duty on government bonds that have for years formed the core of every
middle-class Italian saver’s portfolio, which could sharply reduce their net returns.
These are tough times in southern Europe. Italy’s public debt will top 120% of GDP
this year. It cannot afford to run a big deficit. The government argues that everyone must bear
some pain. Unsurprisingly, then, there was outrage (even privately among ministers) when it
emerged that, for the prime minister himself, the budget contained not pain but an analgesic of
monstrous proportions.
The biggest threat to Mr Berlusconi was never his various trials, even if some could
still cause trouble. His main financial worry is a civil action brought against Fininvest, the
firm at the heart of his business empire, by a company belonging to his long-standing rival,
Carlo De Benedetti. The case arose after the battle over Mondadori, Italy’s biggest publishing
house, in the early 1990s. Three Fininvest lawyers were found to have bribed a judge for a
favourable court verdict. Mr De Benedetti wants compensation. A lower court decided he
should have €750m: big bucks, even by Mr Berlusconi’s standards.
A clause tucked into the 100-odd pages of the emergency budget offered him some
respite by letting any defendant liable to pay compensation of more than €20m suspend
payment until completing Italy’s two-stage appeal procedure. In a system notorious for delay,
that could take years. Amid reports that neither Mr Tremonti nor the League was told of this
clause, the prime minister withdrew it, decrying his critics’“shameless exaggeration”. Even
before this week, it was not easy to see how Mr Berlusconi could reverse the steady decline in
his popularity in time for the next election. Now it looks harder.

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