Why Not Now, Cavaliere?

In light of the markets' disastrous reaction to Italian Prime Minister Silvio Berlusconi's announcement that he will step down only after the Italian parliament has adopted the economic reforms he committed to at the latest meeting of EU leaders, the real question is: are a few more days in office worth running the risk of bringing down Italy and the entire eurozone?

Now that the dust has settled on what was arguably the toughest day of Berlusconi's twenty years in politics, the reality is that Italy's political stalemate has not gone away. Therefore, while the Italian media were celebrating a watershed moment, the markets could hardly see any change at all. But let's start from the beginning.

Yesterday's vote on the 2010 budget review (which we followed here) confirmed that Berlusconi's ruling coalition no longer held a majority in the lower house of the Italian parliament. After the vote, Berlusconi offered his resignation to Italian President Giorgio Napolitano. However, he failed to indicate a date, only saying that he will step down after the economic reforms he committed to at the latest meeting of EU leaders are adopted by the Italian parliament.

Unfortunately, a political leader pledging to resign is not quite the same as a political leader resigning. All the more so if the credibility of the political leader is close to zero, as in Berlusconi's case.

On the other side of Italy's political spectrum, a prominent member of the main opposition party (Partito Democratico) has this morning said, "We're ready to work on Saturday and Sunday" in order to have the new emergency measures adopted by both houses of the Italian parliament by next Monday, because "there's not one minute to waste." The perfect statement in this kind of situation, except for its conclusion, "We obviously reserve the right to vote against the measures."

In the eyes of the markets, this means that the opposition is ready to give up the next weekend, if this is what it takes to kick Berlusconi out as soon as possible. However, if they vote 'no' because they don't agree with the proposed measures, then there's the risk that they will try to scrap at least part of them once (and if) they take over power. Definitely too many 'ifs' to expect anything different from what we're currently seeing in the bond markets (which we discuss here).

In other words, Berlusconi is still the Italian Prime Minister and the opposition still disagrees with him over what needs to be done to drag Italy out of the crisis. In addition, Berlusconi insists that early elections are the only possible way forward after his resignation, despite some senior members of his own party (including the governor of wealthy Lombardy region, Roberto Formigoni) trying to suggest that this is not the right solution given the dramatic circumstances.

Meanwhile, the wholly unelected European Commission is stepping up its pressure - which is in itself problematic as it undermines Italian national democracy (regardless of whether their measures are good or bad for the Italian economy). The monitoring mission, initially scheduled for tomorrow, is already in Rome to seek clarifications on the Italian government's planned economic reforms. In addition, the Italian press has today disclosed a questionnaire sent to Italian Economy Minister Giulio Tremonti by EU Economic and Monetary Affairs Commissioner Olli Rehn last week. The questionnaire (English version available here), which Tremonti is due to compile by Friday, contains 39 very specific questions about where exactly Berlusconi & co. intend to get the necessary funds or savings from.

Crucially, question 2 is,

"As we estimate that in the current economic context the planned fiscal strategy does not ensure the achievement of balanced budget in 2013, additional measures will be needed to achieve the targets for 2012 and 2013. Are contingency measures being prepared already now, and, if so, what kind of measures are they?"

Not willing to let democracy run its course, the European Commission already asking for more. Now that the markets have been completely unleashed, and borrowing costs are well above unsustainable levels, Italy just can't afford to adopt radical economic reforms by a handful of votes and without the backing of the opposition. This is why we stick to our idea (see here, here, and here) that Berlusconi should quit now in order to allow for these badly needed reforms to be adopted by a national unity government with a broader consensus in the Italian parliament.

Otherwise, there is a serious risk that a 'Let me die with the Philistines' scenario for the eurozone could materialise.