According to press reports today the Italian government is preparing to provide a capital injection of up to €30bn ($39bn) for Italy's troubled banking sector. Details of the plan are expected over the next few days, but the main objective seems to be an attempt to ensure the banks have sufficient liquidity to enable them to keep lending to Italian companies and keep an economy which appears to be in danger of seizing up turning over. This news follows weeks insisting from Rome that Itay's banking sector did not need to be recapitalised.
The Italian government is still very reluctant to officially disclose the value of the package, since clearly given the level of Italian public debt this is a very sensitive issue. Berlusconi basically stone walled reporters at a Milan press conference earlier today (Wednesday). He limited himself to stating that the government intended to pass the measures by decree, which is a fast-track way of enacting legislation. He added that the Italian government intended to guarantee some bank debt and buy preferred stock in banks if necessary.
Italian companies have been complaining quite loudly in recent days that the banks are becoming increasingly reluctant to lend or to roll over debts, and this, in an economy where bank loans are the main and often the only form of financing for all except the very biggest companies, is a big problem when it comes to keeping business moving. There is growing evidence - in the form of the slowdown in manufacturing activity and the drop in retail sales - that this is not mere winging, and that there are significant difficulties in obtaining credit. What this means is that the Italian economy is now possibly heading not for a couple of years of zero or slightly negative growth, but for a severe recession. Economists at Capital Economics forecast this week that the Italian economy would shrink by 1.5 per cent in 2009. This seems to be in the right ballpark if we take the data we have been seeing recently seriously, and I personally am revising downwards my own expectations - which weren't exactly high before this current phase set in.
Details of what the government is planning have not been finalised, and talks were continuing among the banks, the Bank of Italy, and the relevant ministries, the bankers said. But the plan may well be unveiled ahead of a meeting of European Union leaders on Friday.
Economic development minister Claudio Scajola has also indicated that the government is in the process of creating a €650m fund to guarantee lending to small and medium-sized Italian enterprises hit by the credit squeeze.
The Italian government approved a decree on rescuing banks on October 9 but the government has still to disclose how it plans to implement it. Unlike other European countries, Italy has not poured any cash into its banks and has not created a special fund to help them. But it has offered to inject capital or underwrite debt if any bank requests it. But a new entity - called the Corporate Financing Fund - has been created and its remit will be to keep open a channel of financing to companies in an attempt to avoid that "in the context of a recession, banks restrict lending and choke companies,'' in the words of Finance Minister Giulio Tremonti.
The government may use tools like perpetual bonds, which pay interest indefinitely, to help finance the plan, according to Vittorio Grilli, director general of the Italian Treasury. The funds for Italian companies will be part of a broader package of measures aimed at helping banks raise their capital levels to make it easier for them to sustain lending.
Government Borrowing Getting More and More Difficult
The yield spread between German 10 year bunds and some other eurozone sovereign debt of equivalent maturity is now the widest since 1997, and investors are demonstrating a preference for only the most liquid of government bond markets as implications of the scale of the European bank bailout begins to dawn on the financial markets. The gap between bunds and their Italian counterparts widened to 127 basis points yesterday, while difference with Spanish 10-year debt was 69 basis points as news broke that the country's economy contracted in the third quarter for only the first time since 1993.
Also we learnt today that credit-default swap traders were prepared to bet more the default risk for Italian and Spanish government debt and Deutsche Bank than on any other comparable risk wager, according to a Depository Trust & Clearing Corp. report that gives the broadest data yet on the credit-default swap market.
A total $33.6 trillion of transactions are currently outstanding on governments, companies and asset-backed securities worldwide, based on gross numbers, the DTCC said in a report released yesterday (Tuesday). After canceling out overlapping trades, investors have taken out a net $22.7 billion of contracts based on Italy's debt, $16.7 billion against Spain and $12.5 billion on Deutsche Bank of Frankfurt, the report shows.
The DTCC, which operates a central registry of credit swaps trades, released the data for the first time as the industry steps up efforts to counter critics among U.S. lawmakers and regulators who blamed the lack of data for exacerbating the financial panic.
Investors have focused wagers on debt of industries and countries that may be most affected by a credit crisis which is now entering its 15th month. The Spanish economy is headed toward its first recession in 15 years amid a slump in its housing market and banking and finance shares have dropped as the credit seizure starts to caused builders and property devopment companies to collapse.
Credit-default swaps on Italy were quoted at 108 basis points yesterday after reaching a record 138 basis points on Oct. 24, CMA Datavision prices on 10-year contracts show. The contracts have more than doubled since August. Yesterday's trading represents a cost of $108,000 a year to protect $10 million of debt for 10 years. Contracts on Spain climbed to 112 basis points on Oct. 24, from about 47 basis points at the start of September. They have since dropped back to 79 basis points.
Turkey, Italy, Brazil, Russia, GMAC LLC, and Merrill Lynch & Co. had the biggest gross amount of contracts outstanding on their debt as of Oct. 31. Turkey alone had $188.6 billion of default swaps written against its debt. The gross amount however doesn't take into account offsetting trades. After netting the trades, there were, for example, only $7.6 billion outstanding on Turkey's debt.
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