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Photo Gallery: Do Italians Really Have Cause to Worry?

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Living 'La Vita Bella' Italians Leave Fears of Debt Crisis to Others

For the financial markets, Italy's debts are a disaster waiting to happen. But after living with the problem for hundreds of years, most Italians would seem to disagree. They insist that no other country knows as much about getting in and out of debt -- and that many of their fiscal strengths go unappreciated.

After so many centuries, the secret door sticks a bit. But it still exists, hidden behind an image of Italy in the "Hall of Maps" of Florence's Palazzo Vecchio. "Eccolo," says Francesca, the custodian. "It happened here."

This is where it all began. Starting sometime in the mid-14th century, the leather-bound ledgers the city of Florence used to record its debts were kept hidden in this secret place. Someone in the city government had apparently hit upon the idea of using the citizens' money to fund the next military campaign. After Florence's (supposedly certain) victory, the city would simply repay the debts -- and with interest.

The wealthy Florentines, who were required to buy their city's debt securities, had their names recorded in the ledgers at Palazzo Vecchio. But, for them, paying up was still preferable to putting on their own suits of armor to defend the city. Besides, they could also sell these new debt securities to others.

The arrangement marked the beginnings of a system of state borrowing and trading in government bonds. Today's $50-trillion (€36-trillion) market in government bonds, which is now forcing governments to their knees, originated in Italy -- first in Venice and, later, in the hills of Tuscany.

The concept of debt securities quickly caught on, and soon the cities of Siena, Florence, Pisa and Venice were hopelessly in debt -- a condition that persists to this day.

Inheriting the Bill

"We currently pay more in interest than we spend on our schools," says Matteo Renzi, who makes the Palazzo Vecchio his home as the mayor of Florence. Renzi, only 36, was voted into office on the strength of his reputation as a "bulldozer" -- and his pledge to finally clean house in Florence. He is the youthful face of his party, the center-left Democratic Party (PD), a mayor who wears jeans and has Apple stickers on his oak desk. "Our fathers walked into the restaurant, and we inherited the bill."

The bill -- at least for his city of Florence -- currently amounts to €518 million.

Many see Florence as the embodiment of the euro-zone nightmare, with massive government debt, close to zero growth and a government led by a man who has been charged with tax evasion.

No other European country, except Greece, is as deeply indebted as Italy. The country's debt level has reached 120.3 percent of its gross domestic product (GDP). At the same time, Italy has one of the lowest birth rates in the Western world, which means that there will be fewer and fewer people to pay off its debts in the future.

'It Was Like a Drug'

On October 4, this combination of factors prompted the Moody's rating agency to downgrade Italian sovereign bonds. Another rating agency, Fitch, downgraded its Italy rating soon thereafter.

Next year, Italy will pay interest amounting to 5.1 percent of its economic output. Greece, at 7.5 percent, is the only European country with a higher ratio of interest to economic output.

Robert Mundell was one of the intellectual fathers of the euro -- and he happens to own a palazzo in Tuscany, as well. But the Nobel laureate in economics still sees Italy's debts as the greatest threat to the euro zone.

"The caste of old politicians ran up the debt without restraint," says Mayor Renzi. "It was like a drug."

Debts were the basis of the "bella vita" period in the 1980s. The political parties pumped massive amounts of money into Italy's poor south, including funding for government agencies and state-owned companies, to keep the social peace and hold on to power. Even today, clientelism, corruption and tax fraud remain symptoms of what is often described as "the Italian sickness."

The constant pressure to reach political compromises drove the bills up. And this continues to happen to this day, as can be seen by the fact that the 10 provincial capitals with the highest debt levels are run by grand-coalition governments.

Bloated Public Sectors

The Italians' behavior didn't improve with the introduction of the euro. On the contrary, Italy took the position that if it could not print its own money anymore, the next-best solution was to incur more debt.

Some 3.5 million Italians are civil servants. Italy spends a full 14 percent of its aggregate output on pension benefits for retired government employees. Only France spends more.

In the south, in particular, nepotism has resulted in bloated public administrations. Mayors, provincial governors and regional prefects shamelessly incur debt to service their clientele with construction contracts or positions in garbage collection. They also line their own pockets.

"We have almost twice as many members of parliament as the United States," adds Florence Mayor Renzi, and the ratio of members of the Italian parliament to the total population is almost twice as high as it is in Germany, as well.

Renzi is determined not to make the same mistakes as his predecessors -- but without spending more money in the process. Renzi is currently suing three banks -- Merrill Lynch, UBS and Dexia -- for allegedly having foisted €50 million in substandard derivative securities on the city. "But it isn't a problem," says Renzi. "We expect to win these cases."

Making Mountains of Debt

The words "bank," "cash" and "bankruptcy" are all derived from Italian, and double-entry bookkeeping was developed in Italy in the late Middle Ages.

The "banche," or moneychangers' banks, stood on the banks of the Arno River, and it was where the Medici, Peruzzi and Acciaiuoli families did their business. They were the first traders in an unlimited money market.

Perhaps out of a sense of guilt, the bankers commissioned painters like Botticelli, Michelangelo and Fra Angelico to create pious works. Even Dante was the son of a moneychanger.

The government debt of the day was ominously known as "monte" (mountain). And if a "monte" was no longer sufficient, it was refinanced with a "monte nuovo," a new mountain. The world's oldest financial institution still active today is the Banca Monte dei Paschi di Siena, founded in 1472.

Marco Massacesi, the bank's chief financial officer, says he's having trouble sleeping these days. This is hardly surprising, given the fact that -- according to the most recent stress test in late 2010 -- his bank's portfolio includes close to €32.5 billion in Italian government bonds. These are the kinds of securities any broker in London's financial district would immediately condemn as "toxic papers."

"But that's not why I'm losing sleep," Massacesi says. "Granted, these bonds are no longer the epitome of security, as they were only a few months ago. But what really worries me is the situation in Europe." Massacesi is referring to Greece and the hesitancy of politicians, including German Chancellor Angela Merkel.

A Banking System Healthier than the Government

Like all big Italian banks, Banca Monte, known as "Il Monte," was downgraded by the major rating agencies in the fall as part of a routine correction for the lenders after Italy's rating had been lowered.

However, the country's banks are not in as poor shape as the government. The large banks have been conservative in their lending practices, and they benefit from a high savings rate among Italians. They managed to survive the financial crisis with almost no government assistance. Hardly any Italian banks have significant numbers of Greek sovereign bonds in their portfolios. According to Massacesi, his bank will not have to drum up any new capital in international market before the end of the year. "Next year," he says, "we'll have to see whether we need new funding."

No other country has such a long history of involvement in debt. High debt levels and little growth have been part of the status quo in Italian budget policy, and the Italians have survived even more serious crises.

A Lack of Concern

Massacesi's office is in a Renaissance palace. Since the Middle Ages, horse races have been held twice a year on a nearby square. For someone who works in such opulent surroundings, the prospect of an imminent demise would seem hard to imagine.

Massacesi insists that Italy cannot be compared with Greece. "We are a rich country," he says. "The Italians own €8 trillion in assets. But the wealth is poorly distributed. We urgently need tax reform." Massacesi also doesn't care if saying this makes him sound like a communist. "Do you know how many times Italy has gone bankrupt?" he asks. "Only a single time, and that was after World War I."

For these reasons, Massacesi sees no reason to panic and remains convinced that the country that invented debt is not about to go under as a result of it. While analysts in London count Italy among the PIIGS countries -- in other words, on a par with Portugal, Ireland, Greece and Spain -- it's hard to find anyone in Italy who is seriously concerned about the government's finances.

Similar Challenges, Different Circumstances

Whenever the issue is raised among Italians, the standard response is that Italy has successfully come down from a similar mountain of debt once before, in the mid-1990s, when then Prime Minister Romano Prodi was preparing the country for the euro.

But, back then, the government budget was in far better shape than it is today. The economy was growing, the government was not spending massive amounts of money to pay off old debts, and there was no risk premium abroad for Italian government bonds.

Those days are gone.

Indeed, it is getting more difficult -- and expensive -- for the Italians to refinance their debt on international markets. The yield on 10-year Italian bonds is currently at 5.73 percent, which is more than twice as much as the 2.15-percent yield on comparable German bonds.

The higher the interest rates being offered to wary investors, the greater Italy's expenses. This, in turn, makes the markets even more cautious. Under these circumstances, some might wonder if this is a vicious cycle or a self-fulfilling prophecy.

Highly Predicated Optimism

"There will be a 20-percent rollover next year," says Marco Valli, chief economist for the euro zone at Italy's UniCredit, in Milan. This means that one-fifth of the government's debt matures next year, and that it will presumably have to be refinanced with new loans bearing less favorable terms.

But, for Valli, this is still no reason to be concerned. "Italy has an average maturity of about seven years on its debt." In other words, newly issued Italian government bonds will mature -- that is, come due for repayment -- in an average of seven years. "This means that the impact of current high-risk premiums will only be felt in the long term. This makes things much easier to deal with."

In its "Fiscal Report September 2011," the International Monetary Fund (IMF) expressed the same view, writing that Italy can "sustain" sovereign risk premiums of three to five percent "for a few years." It's also a good thing that Italians own about half of their government's debt themselves.

"One reason for our optimism is the low level of private-sector debt," Valli adds. "But weak growth is problematic. We have to address the need for structural reforms." According to Valli, one of Italy's problems is the high level of "immobilismo" in the labor market as well as in the service industry, infrastructure and the corporate sector.

"We consider the current debt level to be sustainable as long as we have about 1 percent growth," Valli concludes.

This doesn't sound like much. But the country has been stagnating for over the last decade and, during that period, its economy only grew by an annual average of only 0.2 percent. In late September, Antonio Borges, the European director of the IMF, called Italy's economy "the most worrisome example" of weak growth in Europe. Italy has experienced almost zero growth and no increase in productivity per hour worked.

Mario Draghi, Central Banker and 'German Agent'

What's more, according to Mario Draghi, the new president of the European Central Bank (ECB), this applies "to the entire country, both the north and the south." Indeed, parts of Draghi's farewell speech at the Bank of Italy, the country's central bank, sounded about as upbeat as an autopsy report.

Italy's economic structure is often praised for being fragmented into thousands and thousands of very small businesses. But, when viewed as a whole, this is actually a deterrent to growth. Pharmacists, notaries and lawyers do their utmost to block deregulation, as if they were members of exclusive brotherhoods. As Draghi sees it, on top of that, you also have to add "the policies of governments that do not encourage and often obstruct development."

The result of all these factors is a general state of stagnation. As an example, Draghi takes civil trials. According to his estimate, if they didn't drag on for years, Italy's GDP could jump "up to 1 percent."

For being frank in his opinions, Draghi has already been berated as a "German agent" -- and by none other than Giulio Tremonti, Italy's finance and economics minister.

Selling the Country to Save It

Italy's debts are already eating away at the country's national budget -- which, incidentally, would be in better shape than Germany's if it didn't have the debt burden (see graphic). The government collects revenue wherever it can. Electricity and water are expensive, and revenues from sales and income taxes are higher than in Germany, for example.

Municipalities will be particularly hard-hit by the €54 billion in budget cuts that were approved for the next two years this summer. Libraries will be closed, and fees will increase.

Rome expects to balance its budget by 2014 -- but only if its interest payments don't continue to increase. It isn't as easy to pay off debt as senior government officials optimistically believe. Finance Minister Tremonti, for example, likes to point out that the government would only have to sell its holdings to eliminate the €1.9 trillion in national debt.

A large segment of the economy, a total of more than 13,000 businesses, is directly or indirectly owned by the public sector. This includes the postal service, the national railway provider, parts of the national airline, Alitalia, and electric and water utilities. Tremonti would like to privatize some of these operations. But if he does, he will also have to do without substantial sources of revenue because many of these companies -- such as the government-owned insurance company SACE -- are highly profitable.

The government currently plans to sell some of the real estate it owns, which it hopes will raise €25-30 billion, while the auctioning off of CO2 emissions rights would bring in another €10 billion.

Problems at the Top

Still, perhaps it would be more effective for Italy to completely divest itself of other things that have done much to hurt its image abroad for years -- such as the prime minister.

The fact is that, when evaluating a country's creditworthiness, rating agencies also take into account a government's stability and the qualities of those in leadership positions. In this respect, Italy is at a disadvantage. Last Tuesday, Prime Minister Silvio Berlusconi lost a vote over his administration's 2010 spending review. Then, on Friday afternoon, he barely survived a confidence vote from his own party.

Berlusconi seems to enjoy living the life of an eastern satrap, while his finance minister has been weakened by a corruption scandal involving a close associate. Meanwhile, the Northern League, Berlusconi's important coalition partner, would prefer to introduce its own currency for "Padania," its northern Italian fantasy realm.

The Berlusconi regime has made almost no serious attempts to take any of the steps bankers and the industrial lobby have proposed, including tax reform, deregulation and judicial reform.

Likewise, Berlusconi and Tremonti have been feuding for weeks. Even the appointment of a successor to Draghi, the head of the central bank before he became president of the ECB, has deteriorated into an embarrassing theater of squabbling and power politics.

The Standard & Poor's rating agency stressed that, more than anything, it was Italy's unstable political situation and the debt level that prompted it to downgrade the country's creditworthiness. Its analysts doubt that Berlusconi will be able to continue his austerity program with the current coalition. Indeed, it did not go unnoticed that the premier softened his list of austerity measures the minute the ECB began buying up large numbers of Italian bonds.

Tapping Hidden Assets

Italy's former head accountant is sitting in his favorite Calabrian restaurant near Via Veneto in Rome, eating a plate of Mediterranean sole. "Delicious, isn't it?" he says. For 13 years, until 2002, Andrea Monorchio was the "Ragionere Generale dello Stato," which made him the overseer of Italy's debt and fiscal sins under nine prime ministers.

If anyone knows how bad the situation is, it is this elderly man. Monorchio says he would prefer to not comment on "certain politicians" because he doesn't want to spark any more calamities for the government. "But," he adds, "have you noticed that our national debt corresponds to the total amount of unpaid taxes?"

Still, Monorchio adds, Italy has a kind of wealth that is hard to explain to hedge-fund managers in London. "Italian families own real estate worth €4.832 trillion, of which only 7 percent is burdened with mortgages," he explains. "Every family owns one, two or three houses -- and we're supposed to be part of the PIIGS?"

"With about 20 percent of this wealth," he adds, "we could pay the €950 billion by which we exceed the Maastricht criteria for government debt."

As impressive as these numbers are, the problem lies in finding a way to tap this wealth in fiscal terms. Were more Italians to take out mortgages on their houses to buy government bonds, for example, Italy could eliminate its interest-payment problem. Bringing its sovereign debt back into the country and getting it farther away from the global financial markets would make it easier to control.

Not So Bad If You Ignore the Debt

Monorchio, together with Prodi and the later President Carlo Azeglio Ciampi, was one of the three key economists who guided Italy into the euro zone. He is the prototype of the high-ranking civil servant in Italy, never touched by scandal and equipped with a polite contempt for certain newcomers in Italian (and German) politics.

Like many politicians and bankers in Italy, Monorchio feels that German Chancellor Angela Merkel is one of the people mainly responsible for his country's current plight. As he sees it, the iron-willed "Madame No" has hesitated for too long, he says.

"Our primary balance is positive," he notes, "more positive than that of most other euro countries." In fact, thanks to high taxes, the Italian treasury takes in more than it spends -- but only if the interest payments for existing debts are factored out.

Even the IMF finds this commendable. As European IMF Director Borges said in a press conference in late September: "Italy has the best primary budget or primary balance of all the large European economies, even better than Germany."

In other words, Italy's budget would be stable without its interest burden.

Jealousy Issues

But, of course, this is just one way of looking at things.

Indeed, the world would undoubtedly be a better place if its economies were not as isolated as, say, the Tullio Restaurant near Via Veneto. It would also be a better place if the people in London and elsewhere who Karl Marx once castigated as a "brood of bankocrats, financiers, rentiers, brokers, stock-jobbers and stock-exchange wolves" didn't exist. It is because of them and their instincts that the markets are now unwilling to put their trust in Italian certainties.

"In the end," Monorchio says, "the English are just jealous of us." He nods almost imperceptibly to the waiter and says: "Il conto!" Check, please.

Translated from the German by Christopher Sultan
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