It’s Not the Heat; It’s the Liquidity

It’s not the heat, it’s the liquidity, says Nouriel Roubini on why Italy’s days in the eurozone are numbered.

Even as stocks and Italian bonds posted a recovery after Wednesday’s surge in Italian yields, Roubini, better known as Dr. Doom, said in the Financial Times, the only way to avert “the upcoming disaster is “if the ECB became an unlimited lender of last resort and cut policy rates to zero”, combined with the euro’s value falling to even with the dollar, “fiscal stimulus in Germany” and the deflation in the eurozone’s. Since the ECB can’t do that without rewriting the eurozone treaties, it doesn’t really matter that the other four are basically impossible as well. More to the point, even if Italy isn’t insolvent, the lack of liquidity in its system could be just as fatal.

Meanwhile, an extremely cute economist named Megan Greene agrees with Roubini. Greene has been waiting for the eurozone to go “into full meltdown mode” for months. She says “the only possible way Italy could regain market confidence at this point is if it swiftly implemented a package of austerity and structural reforms under a government with cross-party consensus and a strong, respectable leader, and this package immediately yielded results. This is nearly impossible.” Of course, being cute has nothing to do with it. She writes a blog called Euro area debt crisis. I’m going to assume that if your blog title is that specific, you’ve got a pretty good read on the situation. My favorite tab on the blog is “Beyond the Pigs.” It lends itself to so many interpretations.

Roubini says Italy, and the next bailout in line, Spain, are “too-big-to-fail but also too-big-to-save,” and will need a restructuring of 1.9 trillion euros of public debt. However, the European financial stability facility has already committed half of its resources to Greece, Ireland and Portugal, leaving just 200 billion euros for Italy and Spain. Efforts to leverage that 200 billion euros to 2 trillion, “is a turkey that will not fly, because the original EFSF was already a giant collateralized debt obligation, where a bunch of dodgy, sub-triple-A sovereigns try to achieve, by miracle, a triple-A rating via bilateral guarantees.” He calls it another “a giant sub-prime CDO scam.”

Still Wall Street isn’t going down easy. After Italy passed an austerity measure, the S&P 500 jumped 2% to 1264 and the Dow Jones Industrial Average climbed 2.2% to 12158. The yield on Italy’s benchmark bonds fell to 5.69%.

The rebound was so strong that some of the ETFs that tumbled on Wednesday are now trading above Tuesday’s close. These include the PowerShares DB Italian Treasury Bond Futures ETN (ITLY) up 3% to $18.25 and the PowerShares DB 3x Italian Treasury Bond Futures ETN (ITLT) up 10% to $14.29. These ETNs measure the performance of a long position in Euro-BTP futures, whose underlying assets are Italian government debt with an original term of no longer than 16 years. The ITLT ETN provides leveraged exposure three times greater than the unleveraged bonds.

Meanwhile, while not above the Nov. 8, close, these still made a nice recovery. The iShares MSCI Italy Index Fund (EWI), which tracks about 85% of the Italian equity market, gained 4% to $13.24 and the CurrencyShares Euro Trust (FXE), which offers U.S. investors a way to bet on the euro without trading on the foreign exchange markets, climbed back to $137.