The Italian Job

Over night, the Italian 10 year bond yield jumped over 500 basis points (a basis point is 1/100 of a percent).

It sent shudders through the entire global financial system, tanking equity markets everywhere and setting off a political firestorm in Italy and Euro centers of power. Italy is too big to save. It simply has too much debt and losses on that debt will devastate dozens of Eurozone banks. Emergency meetings are probably under way across Europe and Washington.

I have a hypothesis that the bankruptcy of MF Global forced a large liquidation of Italian bonds, causing big losses, stop loss triggers, followed by margin hikes on the bonds, and more panic selling. The loss of marked to market principal on Italian bonds alone was hundreds of billions of dollars in one night. I'm sure other factors came into play, but I think the death of MF Global was one of the matches that lit the fire.

I only see two ways this can now end. The ECB can start monetizing PIIGS bonds with massive buying, which is currently against the law. Or, each country can set the terms of their own restructuring, and each country will be responsible for recapitalizing their own banks. Either option might work out OK for Italy, but the second would be an ugly, chaotic event for Greece, which would probably be forced off the Euro and back to drachma. The same goes for Portugal and Ireland. Spain is much harder to call.

I've heard over the last few months how leaders need to restore "confidence to the markets". When I hear that, it gets translated in my head to "continue fooling you with lies and fake accounting". In 2008, deep seated corruption and lies came frothing to the surface. Scams and frauds have continued to wash up on the financial shores as they collapse. The missing $600 million in customer accounts at MF Global is just the latest.

However the Italian job plays out, major changes are coming to the Eurozone, maybe sooner than later.