Italy’s in Play

At least Italian savers are offered a decent return on their money. 7% on ten-year debt is a bit more like it – at least after taxes and inflation you stand a chance of being ahead of the game, unlike in the U.S. where government policy is hostile to savers and seeks to inflict real losses of purchasing power on anyone desperate enough to invest in government bonds. We could use some Italian yields here in the U.S. However, in Italy there’s just the non-trivial question about ultimate repayment. Meanwhile, Senior loans in the form of two closed end funds, PPR and BHL, yielding around 6% seem a much better bet. Diversified credit risk to leveraged corporate borrowers with short duration, versus concentrated sovereign credit risk with dysfunctional government and long duration. There’s no yield at which we’d invest in Italy; we did buy more of these two funds yesterday.

If the sellers of Italian bonds over the past few days have been banks, it would be wholly understandable. The “voluntary” 50% haircut they agreed to over Greece clearly sets a precedent rather than being unprecedented. Combined with the natural consequence that sovereign credit default swaps have questionable value (since the 50% write-down likely won’t trigger a default event) return of capital is trumping return on capital. Forecasting where the crisis will end remains a complex struggle, but by now we’re becoming trained to contemplate the unthinkable. Markets even seem to have moved beyond the EFSF and that leaves just the IMF to bail out with real money and strings attached, or ultimately the ECB to create money.

What a surreal outcome that would be given that the ECB’s constitution was modelled on the Bundesbank’s and more or less dictated by Germany. And of course it may not happen. But with Italy now “in play” so to speak, yet another unthinkable is now a headline. German policymakers will have to wrestle with their deep-seated fear of inflation and their perhaps equally strong desire to maintain the Euro in is present form. We maintain a short € position (through being long EUO) as a hedge on some of our leveraged strategies. We reduced the position yesterday – it’s not that the crisis is over, but obviously everyone gets the joke by now so the $/€ exchange rate provides less protection than it used to.