As Greece, and Portugal, and recently even Spain bask in the spotlight of the bond vigilantes, I want to remind my subscribers to be prepared for Italy's turn to dance. Subscribers should reference 
Italy public finances projection 2010-03-22 10:47:41 588.19 Kb for the skinny on Italy's "realistic" prospects, and Italian Banking Macro-Fundamental Discussion Note for a list prospective candidates to monetize this view in the banking industry. As of the last time I checked, the market hasn't hammered them yet... Complacency???
In Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware! we scanned anecdotal evidence of Italy hiding the Italian sausage...
As discussed in a recent ZeroHedge article, a 1996 Italian currency swap, arranged by J.P. Morgan, allowed Italy to receive large payments upfront that helped keep its deficit in line, with the downside of greater payments later.
In addition, to curbing their current deficits, countries are now using these swap agreements to push off their loan liabilities (related to swap agreements) to a later date through securitization, and Greece is one such example.
Under the 2001 deal brokered by Goldman, Greece swapped dollar- and yen-denominated debt for Euros at below-market exchange rates. The result was that the country got paid €1 billion ($1.35 billion) upfront on the swap in exchange for an obligation to buy the swaps back later. In 2005, this obligation was in turn securitized as part of a 20-year debt issue, further pushing off the day of reckoning.
Moreover, one of the key reasons why such manipulations continued is the apparent ignorance of the EU's Eurostat, which knew enough about these deals to tighten the rules governing their accounting-albeit only after they had served their purpose - the Ponzi! When Italy's then-Prime Minister Romano Prodi miraculously achieved a four-percentage-point improvement in Italy's budget deficit in time to usher the country into the common currency, Italy's use of accounting gimmicks was widely discussed, and then promptly ignored. As at that time, everyone was only too eager to look the other way in the drive to get the single currency up and running.
It wasn't until 2008-a decade after the deals became popular-that Eurostat was able to revise its rules to push countries to include swaps in their debt and deficit calculations. Still, till date too little is known about countries' continued exposure to the deals that are already out there.
Overall, though there is less evidence to support that there are more such swap deals that happened during the late 90's till early part of this decade, the data below showing a sharp decline in interest payments as a percentage of GDP particularly for Belgium (apart from Greece and Italy), hints that there are considerably more of these deals to be discovered. The questions is, will they be discovered before or after the respective sovereign issues record debt to the
suckerssovereign fxed income investors.
Notice the extremely supercalifragilisticexpealidocious reductions Belgium, Greece and Italy have made in their interest payments from 1993 to 2000 in this graphic made pre-2000. If one didn't know better, one would have thought theses countries actually used magic to make such reductions. Hell, Italy practicaly cut their debt service (projected, of course) in half. It really makes one wonder. I'm just saying...
According to DERIVATIVES AND PUBLIC DEBT MANAGEMENT by Gustavo Piga, "The political stakes of the 1997 budget package were enormous. Therefore, it was no surprise that many countries were accused of 'creative window-dressing' in their budget through the use of accounting tricks to reach the desired goal. One contentious item was interest expenditure, which is the interest expense that governments sustain to finance their deficit and roll over their debt. Interest expenditure represents a high percentage of public spending and GDP in the European Union. It is highly variable over time, especially when compared to other components of the budget. Because of its relevance and because it is subject only to minimal scrutiny during budget law discussions (and many times even after its realization during the fiscal year), interest expenditure is an ideal target for reaching fiscal stabilization goals without incurring excessive political protest or opposition".
In Once You Catch a Few EU Countries "Stretching the Truth", Why Should You Trust the Rest? I excerpted a few snippets from the subscription only report (
This is Italy's presumption of economic growth used in their fiscal projections:
You see, the Italian economic situation wasn't that great to begin with since they were one of the hardest hit in the recession of 2009.
If their overstatement of the ability to pull out of this falls flat (which it most likely would) then you will see a spike in devt service and interest, of course accompanied with the tried and true "Nobody could have seen this coming" statement from the BIS. No, not the Bank for International Settlements, but the Bureau of Internal BS (excuse my Italian).
And in Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! I show how even though Italy's projections make the EU and IMF numbers look overtly conservative, the reality of the situation is that even those numbers are, and have been for years, pie in the sky!
This is Italy's presumption of economic growth used in their fiscal projections:
This is a sample of what was received in the Italian subscription content. As I type this, I see those who were truly believers in the Spanish Banking Macro Discussion Note and the Spain public finances projections and used puts to monetize those views are now pushing the 600% profit mark! Kudos to those who took the correct positions.
Below is the market for these options at the approximate time I released the Spanish research. I truly believe the market is coming nowhere near appropriately pricing the risk of European contagion in the capital markets. I will be exploring this issue in depth in the discussion and comment forums of BoomBustBlog over the next week or two.
Follow my ongoing analysis of the Sovereign Debt Crisis, now over 30 articles strong and available to the public.
