No quantum leap on eurozone integration after the German elections

Our Director Mats Persson has an op-ed in today's Wall Street Journal, where he argues,

A satirical cartoon in the Italian magazine L'Espresso, depicting a father and son, illustrated it best: "Papa," says the son, "I have to go to the toilet."

"Hush," answers the father. "Hold it until after the German elections."

By now most commentators have realized that there won't be a quantum leap toward more eurozone integration following the German elections. However, while most have focused on coalition dynamics, there are in fact three far more profound limitations that will continue to restrict Germany's ability to act in Europe long after the Sept. 22 elections, and will prevent any swift move toward a euro-zone banking union or fiscal union: One of these limitations is political, one is constitutional and one is economic.

First, German public support for the euro remains highly conditional. According to a recent Open Europe/Open Europe Berlin poll, a majority of Germans support more euro-zone integration if it means more central controls over other countries' taxation and spending. However, a clear majority remain opposed to any policy that involves putting German cash on the line, such as further loans to struggling euro-zone countries, write-downs of existing loans, a joint banking backstop or fiscal transfers.

This is neither surprising nor new. In the 1990s when the euro was forged, the gulf between public and elite opinion was already conspicuous. But despite mounting scepticism, the cost of saving the euro hasn't actually trickled through to people's wallets. If that ever changes, via a slow-down in the German economy, or if savers start to really feel the pinch from the European Central Bank's low interest rates or future possible money printing, we may quickly hit the limit of what the public is willing to endure.

Let's not forget that, given Germany's regional structure, there's almost always another election on the horizon. Between now and when Greece is supposed to exit its bailout program in June 2015, for example, there will be at least five state elections in Germany, as well as the European elections in 2014. German politicians cannot escape public opinion.

Second, the German republic was set up after World War II specifically to prevent hasty centralizations of power. Ironically, this was done at the behest of the Americans and the British—though both Washington and London have been vocal critics of Berlin's cautious approach in the euro-zone crisis. Systemic circuit-breakers such as Germany's Constitutional Court were put in place to counter rash decision-making, while the modern German constitution in 1949 got rid of the federal government's Weimar-era emergency powers.

Today, slowness and consensus are encoded in the very fabric of the German constitutional DNA. This will not change after the elections, nor should we wish it to. While it is unlikely to rule against the ECB's bond-buying program, the Constitutional Court will continue to lay down new red lines for what Germany can and cannot do. The Court has already said that before the euro zone moves to a transfer union, a change to the German constitution will be needed, which will first require a referendum.

It's constitutionally complicated, for example, to write down Greek debt, given that 75% of it is now owned by taxpayer-backed institutions in Germany and the rest of the euro zone. If those institutions take losses on what until now have been loan guarantees, that will in effect turn the euro zone into a transfer union for the first time, which the Constitutional Court has said is illegal. German politicians will continue to have one hand tied by the court in Karlsruhe for years to come.

Then there is the third and most fundamental limitation: Germany can't afford to underwrite the euro forever. If implicit debt, such as the liabilities of Germany's social-security system, are taken into account, the real level of German public debt would be 192% of GDP—much higher than Italy's 146%. Germany has also racked up an exposure to the struggling peripheral countries of around €1 trillion—equivalent to some 40% of its GDP. If Berlin were to begin accepting losses on this, the cost could snowball quickly, as all its sovereign debtors would look for equal treatment. Furthermore, Germany faces a demographic time bomb.

By 2050, the country's current population of 82 million is projected to have declined to around 70 million—less than in 1963. Far fewer workers will be around to finance the country's pay-as-you-go social-security system. This is worse than it looks. Germany, of course, already has its own deeply unpopular transfer union. In this system, out of 16 federal states, only three—Bavaria, Hesse and Baden-Wurttemburgh—are permanent net contributors, with Hamburg moving in and out of that status. Under a hypothetical euro-zone transfer union, these four German regions would proportionally carry a huge burden.

All of this means that there's a relatively stable trajectory to German's EU politics, which defies electoral cycles. So can we expect any movement after Sept. 22? Maybe a little. Particularly in a coalition government that included the center-left Social Democratic Party, we may see some easing of austerity in favor of structural reforms in countries such as Greece or Portugal. But Germans won't give up their deep-held belief in frugality overnight.

Almost any German government is also likely to continue to insist on strong controls over other countries' taxation and spending, most likely via the EU institutions, as quid pro quo for more cash. So the complicated sequencing that's pitting the Germans against the French will continue to dog the euro zone. Make no mistake, Germany will remain a slow, deliberating and frustrating actor for years to come.

Vice-President of Italian Senate has a go at 'Mr Nobody' Olli Rehn

Maurizio Gasparri, a senior member of Silvio Berlusconi's PdL party and a Vice-President of the Italian Senate, yesterday launched one of the toughest verbal attacks on a member of the European Commission we can think of over the past months, if not years. His target was EU Economic and Monetary Affairs Commissioner Olli Rehn, and here's what Mr Gasparri said,

It's time to stop it with the 'corporals of the day' such as this Olli Rehn, a Mr Nobody who comes to Italy acting as a supervisor. He should rather meditate on the disasters that people like him have caused by destroying Europe. Thick bureaucrats who kill the peoples [of Europe] and make the continent die because of China’s unfair competition and [their] ruinous economic policies. This Rehn is persona non grata. He should take a plane, go back home and pay as many taxes he likes.

But what prompted this rant? Very simple. During a hearing in the Italian parliament earlier in the day, Rehn had noted that the abolition of a controversial property tax on first homes – one of Berlusconi's flagship electoral pledges – was not in line with the European Commission's economic policy recommendations to Italy, and cast doubts over the country's ability to meet the deficit targets agreed with Brussels.

Interestingly, Mr Gasparri's critical reaction to Rehn's remarks was not the only one of the day either, though arguably the most colourful. Stefano Fassina, Italy's centre-left Deputy Economy Minister, also invited Rehn to "think about the mistakes the European Commission has made in all these years instead of continuing to give us lessons." Another sign that 'austerity fatigue' in Italy is also mounting among a number of top politicians, not just the citizens.   

Ten years on, what Britain can learn from the Swedish euro referendum

Last Saturday was the tenth anniversary of the Swedish referendum on the euro, and our Director, Mats Persson, wrote this piece for the Guardian's Comment is Free:

"The best argument against democracy is a five-minute conversation with the average voter," Winston Churchill famously said. He could have added that the best argument against elite rule is a five-minute conversation with your average politician.

I used to be sceptical of referendums. They are populist instruments, I thought. Voters never vote on the actual issue. And what do voters know anyway? Then the euro happened. 

Saturday is the 10-year anniversary of the Swedish public voting no to joining the euro in a high-profile referendum, 56% to 42%. The Swedish elite was in shock. All the major parties, the national newspapers, the business organisations, including the Swedish CBI, and most of Stockholm's chattering classes favoured ditching the krona. According to some estimates, the yes campaign outspent the no campaign 10 to one. There were a lot of clever and genuine people on the yes side, making valid arguments such as eliminating exchange risk for business and replacing the flaky devaluation policies of the past.

However, it was obvious that something wasn't quite right. Yes, perhaps Sweden could benefit from sharing a currency with Germany, the destination of many of its exports. But the euro wasn't about liberal economics: stretching from the Arctic circle to Sicily, it locked vastly different countries, cultures and economic structures, into one monetary system, under a single interest rate – forever binding together the problems of all its members, large or small. It was a system based on the hopelessly flawed assumption that politicians and central bankers would make the right decisions all the time.

As with all referendums, there were various reasons why the Swedish public voted no, including an inherent bias in favour of the status quo. Fundamentally, though, most Swedes' gut instinct – bondförnuft as the Swedes say (literally "farmer's common sense") – told them that a serial defaulter with dubious finances, Greece, and a heavily industrialised exporter with an obsession with sound money, Germany, simply couldn't share the same currency. Swedes treated the exam question with the same kind of book-keepers' approach by which many of them run their own household economies. Whatever the experts told them, the arguments – and the numbers – simply didn't add up.

Ten years on, Europe is shrouded in uncertainty, but one thing is clear: the Swedish public got it right, the elite got it wrong. Though there may have been some politicians in Sweden and elsewhere who saw the single currency as the ultimate way to set the snowball rolling towards an EU superstate, the euro was far more a case of cock-up than conspiracy. Today, 80-90% of Swedes oppose the euro, and the political and business elites are wary too – save the odd isolated politician doing an impression of the Japanese soldiers found in the 1960s refusing to believe the second world war had ended.

However, referendums are by no means a magical potion. It's clear that there are cases where they're hijacked or misused – and where they lead to outcomes that no one intended or that settle nothing. Sweden itself has some less successful experiences with public votes. In 1980, a three-way referendum on whether to ditch nuclear power – arguably a populist kneejerk response to the Harrisburg disaster – generated a vote in favour of a vague plan to incrementally dismantle all nuclear plants. The result was totally inconclusive, leaving half the country embittered on the issue (Sweden still has nuclear power today).

Incidentally, there's a lesson for David Cameron here. He has promised to negotiate a new settlement in the EU and put that to an in/out referendum by 2017. If that indeed happens, the worst possible outcome is a 49-51% type result, too close to call in either direction. As in Sweden in 1980, much of the population would feel disenfranchised and the EU debate will continue just as before. This isn't in either the UK's or Europe's interest.

To avoid this scenario, there needs to be substantial and systemic changes, ideally rooted in EU-wide solutions so that they last (unilateral opt-outs tend to be eroded). That would allow a decisive vote in favour of the UK staying in a heavily reformed, slimmed-down EU.

One can have different views on Cameron's strategy, but given public and political discontent about the EU status quo, sooner or later there will probably have to be a referendum to settle the Europe question in this country. And as the Swedish euro vote shows – warts and all, the public can opt for perfectly rational and responsible outcomes that would not occur if politicians were left to their own devices.

Could the decline in Spanish house prices be bottoming out? Not just yet...

A quick update on Spanish house prices, given that the latest quarterly statistics were released this morning.

As the graph highlights the second quarter of 2013 saw the smallest decrease in house prices quarter on quarter for some time. A few points to note here, though:

• Q1 2013 saw the largest decline for some time so the rebound could be impacted by the fact that the previous decline had been extraordinarily large. The rate of annual decline, at 12%, remains rapid.
• House prices, according to INE, have now fallen by 37% from their peak in Q3 2007. This is clearly a huge decline, but as we have pointed out before, a decline of up to 50% cannot be ruled out, meaning prices may still have some way to go before they bottom out.
• As with other statistics in Spain, there could be some seasonal impact which is yet to be accounted for.
  

• As the graph above shows there is also a wide range of regional variation with some of the richer areas beginning to fair better.
• The year-on-year decline, from Q2 2012 to Q2 2013 is seen to be around 8.8% by INE. However, recent statistics from Tinsa put the decline over the same period at 10.5%. It’s hard to say which is more accurate but this is a notoriously difficult area to accurately measure. There is some (fair) concern that the indices may fail to capture the true decline in house prices in Spain as they do not accurately reflect market transactions, so any data should be read with that in mind.
• Interestingly, it has also been suggested that that while domestic demand has continued to fall, 2013 Q2 saw a pick up in interest from foreign buyers. This could be a positive sign, although (as we have pointed out for the wider economy) foreign demand is not likely to be sufficient to offset a cratering in domestic demand.
• The growing difference between new and second-hand housing is also interesting, if not unexpected. The construction sector will likely continue to struggle as long as new buildings do. The slightly positive signs for second-hand housing could also be positive for the banks, since the majority of their mortgage portfolios will be linked to these properties – if they begin to show signs of recovery the mortgage books may begin to look less toxic (early days though yet). Clearly, as the decline continues and other factors (such as unemployment) continue to push up the level of bad loans that banks hold, they are likely to continue to struggle.
• All that said, the problems with prices of new houses do not bode well for the significant amount of unsold new housing stock floating around in Spain (though to be around 1 million properties) or the large swaths of un-developed land owned by the banks. Clearly these factors will drag on the economy for some time.

Housing, real estate and construction are likely to continue to be a drag on Spanish economy. The concerning point remains that the Spanish economy has been slow to adjust and rebalance towards new areas for growth. Meanwhile, with the ECB's asset quality review (aka 'stress tests') coming up at the start of next year, the attention to the state of bank balance sheets and their links to the housing crisis are likely to once again intensify.

Third EU legal opinion of the week, this time on banking union: bad news for Germany?

It seems to be a week for big legal opinions in the EU. We've had opinions on the FTT, the EU’s short selling regulation and now on the European Commission’s plan for a Single Bank Resolution Mechanism (SRM) – a key component of the banking union.

We have noted the importance and implications of the others, but this might turn out to be the most significant - although it is far less categorical in terms of ending the debate.

As we noted when the SRM proposal was published, the plan is based on a significant legal stretch where the 'single market article' (Article 114 of the Treaty on the Functioning of the European Union, TFEU) is used to justify transferring bank resolution powers to the Commission. In particular, Germany raised concerns regarding this legal base, suggesting treaty change may well be needed.

In the meantime, the EU Council of Ministers' Legal Service had been tasked (by the relevant working group for the proposal) with answering two key questions:

i) Whether Article 114 TFEU is the suitable legal basis for adopting the proposed Regulation;
ii) Whether the delegation of powers to the Board envisaged in the proposal is compatible with the EU Treaties and the general principles of EU law, as interpreted by the so-called 'Meroni' case law of the ECJ (see here for some background on the case).

Those who have followed our coverage of the other decisions will notice significant similarities with the short-selling case for example, given that the questions focus around the use of Article 114 and the 'Meroni case'.

However, in this instance the legal opinion seems to mostly side with the European Commission:

"The Council Legal Service has reached the conclusion that the centralised decision procedure described in the proposal cannot be regarded as an isolated regulatory measure with autonomous purposes, but is conceived as an element contributing to an on-going harmonisation process in the field of financial services, without which its establishment would have no sense."

Essentially, the Legal Service shares the Commission's view that the SRM proposal is needed to prevent fragmentation of the single market and that it will be applied uniformly. It also notes that the SRM is vital to the implementation of the Bank Recovery and Resolution Directive and the Capital Requirements Directive (the bank bail-in plans and the EU’s transposition  of the Basel III rules, essentially), while also arguing that, given the move to a single supervisor, a single resolution mechanism makes sense. Later on in the opinion, it is noted that the judgement on whether the necessity of an SRM set up in such a manner is ultimately a political decision – leaving it open to interpretation.

Furthermore, the opinion does contain an interesting caveat:

"The proposal does not contain a robust system to guarantee the budgetary sovereignty of Member States, notably throughout the transitional period during which the target funding level has to be achieved. Purportedly, during this period, the Fund will not have the necessary means to face conveniently resolution decisions and recourse to extraordinary means of funding might be needed…the Council Legal Service is of the view that the use of Article 114 TFEU as legal basis of the proposal would be contingent upon the introduction of an adequate system to safeguard the budgetary sovereignty of Member States."

This highlights that the creation of the single resolution fund could have financial implications for the budgets of member states (an issue which usually requires unanimous approval). This is especially true given that the funds built up from industry levies will not be ready for some time (up to ten years).

The FT notes that the German government has focused on this point and stressed the need to protect budgetary sovereignty. It has also suggested that the recent ruling on the UK short selling case actually backs up their position, given that it shows the limits of article 114 and highlights the limits to transferring new powers to EU institutions (we’re inclined to agree with them on this one). Today's legal opinion reinforces the German government "in its central legal concerns", says the German Finance Ministry.

It seems clear that this opinion is unlikely to settle the debate. Even if it is judged legally sound, the proposal remains hugely controversial from the political point of view. That said, with Germany still weighing up whether to try to renegotiate the proposal or push ahead with its own intergovernmental plan, this opinion could shift the balance.

Berlusconi's swan song may not be easy listening for Letta

September has come, and summer is (almost) over - but the heat won't leave Italy for a bit. The Italian Senate's Immunities Committee has begun debating whether to strip Silvio Berlusconi of his seat as a result of his recent tax fraud conviction. As we wrote on this blog several times (see here, here and here), the outcome of the vote that will follow this debate could be decisive for the future of Prime Minister Enrico Letta's shaky coalition government.

A quick recap:

• Under Italy's new anti-corruption law, Berlusconi won't be able to stand for election for the next six years due to his tax fraud conviction. As we said, he also risks losing his seat in the Italian Senate.

• Berlusconi's PdL party wants to delay the vote in the Senate's Immunities Committee, arguing that the opinion of the Italian Constitutional Court and the ECJ should be sought first. The legal reasoning behind the request is that, according to Berlusconi's party, the anti-corruption law can't be applied retroactively - that is, it doesn't cover crimes committed before its entry into force in December 2012. The problem is the other parties (including Mr Letta's Democratic Party, currently in government with Berlusconi's PdL) are not on the same wavelength and want to wrap everything up as quickly as possible.

• A preliminary vote on the request to refer the matter to the Constitutional Court and the ECJ could take place tonight or tomorrow. It remains unclear when the final vote will happen. However, several key members of Berlusconi's party have made clear that, if the Committee refuses to delay the final vote, it will be the end of the coalition with Mr Letta's Democratic Party.

In other words, Italy seems to be heading towards fresh political instability. If the existing coalition collapsed, snap elections would become a concrete possibility - but not the only one. The ball would once again be in the court of Italian President Giorgio Napolitano, who would presumably try and put together an alternative majority (with the help of 'rebel' Senators from Beppe Grillo's Five-Star Movement and Berlusconi's party) before throwing the towel in and dissolving parliament. 

German election update: Lucke hits back

An interesting story caught our eye in today's Welt concerning next month's German elections. Bernd Lucke, the head of the anti-euro Alternative für Deutschland party (seemingly undaunted by a recent attempted assault on his person) has written a letter to German President Joachim Gauck asking for access to documents in which the German government has simulated different scenarios to save the euro, citing Germany's freedom of information laws. The move fits with the party's theme of "having courage for the truth" (Mut zur Wahrheit), which it accuses other German political parties of lacking.

This comes after the same request addressed to the Chancellery, Bundesbank and German banking supervisor Bafin was rejected on the basis that the information is held by the eurozone's network of central banks, and therefore falls outside the scope of German law. Lucke has criticised such "questionable" behaviour on the part of German officials, while noting that the Bundesbank's refusal to reveal the information shows that it is de facto supporting the German government when it should be a politically independent actor.

While we're not expecting the information to become public soon, the documents would certainly make for interesting reading as they would reveal how the German government assessed the costs of a breakup, and therefore whether its subsequent policies for dealing with the crisis have indeed been 'alternativlos' as Merkel has argued, or whether alternative policies were jettisoned due to the short-term political and/or economic implications.

Germany finally admits to a third Greek bailout, but what form might it take?

It seems the German government has finally publicly accepted what everyone already knew – that Greece will need some kind of further financial assistance after its second bailout programme expires at the end of 2014. German Finance Minister Wolfgang Schäuble told a CDU election rally yesterday:

"There will have to be another [bailout] programme in Greece," in order to help the country "get over the hill" of debt repayments it faces.

Despite attempts from both the German Chancellor Angela Merkel and German finance ministry spokesmen to row back from the comments and suggest they are not, in fact, a change in stance, the remarks seem to have stuck.

What form might the third bailout package take?

• According to the IMF, Greece's total funding gap up to the end of 2015 is around €11.1 billion (5.8% of GDP) – so this can be taken as a lower bound of the funding needed. Privatisation receipts (which have notoriously fallen short) are expected to reach €7.7 billion over the next three years. Further shortfalls here could push up funding needs.

• A further extension of maturities and reduction in interest rates on the official sector loans, as suggested by EU Economic and Monetary Affairs Commissioner Olli Rehn also seems likely. However, interest on loans from the EFSF - the eurozone's temporary bailout fund - are already at cost and payments have been deferred for ten years. The IMF is also unlikely to reduce its interest rate as this would amount to a form of debt restructuring, which the IMF refuses to engage in due to being the most senior creditor. This leaves only the eurozone's bilateral loans from the first Greek bailout, the interest on which has already been reduced to around 1.5% (well below most eurozone states' long-term borrowing costs). Therefore, scope for further reduction is limited, and the benefit it could provide would amount, at most, to a couple of billion spread over a long period, as we have previously noted.

• Another widely touted proposal is to use the leftover funds originally allocated for Greek bank recapitalisation. So far, according to the IMF, Greek banks have received €40.9 billion out of an allocated €50 billion. Although it seems the EFSF expects this to increase to around €48.2 billion. It is likely some additional buffer will be needed, given the pace of increase in bad loans in Greece, meaning the amount available is likely to be between €2bn and €4bn max.

• A final idea, reported by Süddeutsche Zeitung, is that EU structural funds could be able to provide some of this funding. It’s not clear exactly how this would happen and, as we’ve noted before, we're sceptical of the idea that there is lots of excess money floating around to be easily reallocated in the EU's structural fund programme. Given that the new EU budget headlines for 2014-2020 are set, it's not clear how much more money can be squeezed out for Greece. One option would be to adjust the 'co-financing rate' (the amount the Greek government contributes to each project to gain funding) but this has already been adjusted and provided little boost to the take up of funds, which remains well below target.

Lots of questions to be answered then about the size and format of what may be the trickiest Greek bailout to date, given the tough political constraints and the on-going (very tenuous) premise of debt sustainability. An important consideration, as Schäuble suggested, will be to get Greece over its funding hump in the next couple of years (data from Greek debt bulletins):

The final point to note is the continuing German aversion to further debt relief for Greece, something the IMF and nearly all private observers accept is necessary. Within Germany, this seems to be a result of the government 'learning its lesson' from the first Greek debt restructuring, which patently failed. However, the German government seems to be learning the wrong lesson for the wrong reasons – it was not that restructuring was a bad idea in itself, but simply that all such a large amount of debt was held by Greek banks that the ensuing recapitalisation and bailout negated any benefit.

The German government clearly remains loathe to discuss any such details, meaning a clear plan is unlikely to emerge until the end of the year. In the meantime, we can’t help but wonder how the Greek public will react to the prospect of another bailout with another set of conditions attached. Could the big unknown outside the eurozone begin to look attractive once again? Maybe, or maybe not - but it may well start to factor into their thinking at some point.

Colpevole: Supreme Court had bad news for Berlusconi (and the Italian government)

It took everyone a while to figure out what the Supreme Court final verdict in Silvio Berlusconi's tax fraud case meant in practice. Let's start from the easiest part: the four-year prison sentence has been definitively upheld. As we explained here, Berlusconi will only have to serve one year in reality - with house arrest or community service the most likely options, given his age.

The Supreme Court also said the five-year public office ban was excessive under Italian law and had to be cut down - so it referred it back to the Court of Appeal for review. In other words, it seemed Il Cavaliere had at least temporarily dodged the ban - arguably more important than the prison sentence from his point of view.

However, a new twist to the story emerged last night. Under Italy's new anti-corruption law, which was passed at the end of 2012 by Mario Monti's technocratic government, Berlusconi will not be allowed to stand for election for at least six years as a result of his tax fraud conviction. In practice, this means Berlusconi will not be able to run in the next Italian elections even if Letta's government saw through the entire five-year parliamentary term.

But there's more: Berlusconi also risks losing his seat soon(ish). According to the same law, the Italian Senate will have to vote on whether to expel Berlusconi with immediate effect. This vote will probably take place at some point in September - and will turn into a key test for the stability of Italy's coalition government.

So, in substance, the lose-lose scenario for Italian Prime Minister Enrico Letta's Democratic Party that we discussed here is materialising after all:

• If the Democratic Party votes to expel Berlusconi, it will put Italy's coalition government at risk;

• If the Democratic Party votes to keep Berlusconi in, it will put itself at risk of internal strains and criticism from angry voters. It would also provide a boost to Beppe Grillo's anti-establishment rhetoric.

At some point Mr Letta will have to decide whether it is acceptable for his party and his electorate to stay in government with a party whose leader has just been convicted for tax fraud. Italy's short-term political stability could also depend on the answer to this question.

Following the verdict, Berlusconi made a rather emotional statement. It was a political 'call to arms' for his supporters, with no mention of Letta or the future of Italy's coalition government. Berlusconi insisted he is the victim of "judicial doggedness without equal in the civilised world" and pledged to "fight on". We are pretty sure he will.

Verdict day for Berlusconi: Could a lose-lose scenario materialise for Letta?

Supreme Court judges in Rome have started deliberating, and the final verdict in Silvio Berlusconi's tax fraud case is expected by this evening. The former Italian Prime Minister is appealing against a four-year jail sentence and a five-year public office ban (see our reader-friendly Q&A for more details).

If the Supreme Court upholds the conviction, it would be the first time Berlusconi is issued with a definitive sentence, with no more appeals left. However, two further points of background are worth noting:

• As we explained in our Q&A, if Berlusconi were convicted by the Supreme Court, the Italian Senate would have to vote on whether to lift his parliamentary immunity. However, the immunity would not cover the jail sentence - which would be enforced anyway because it would be a definitive one (although in practice it would almost certainly amount to house arrest, given Berlusconi's age). 

• A majority of Italian Senators could potentially overturn the Supreme Court ruling on this point. This would mean that Berlusconi would not have to resign as a Senator, and would be allowed to stand for election in future.

Interestingly, Prime Minister Enrico Letta's centre-left Democratic Party (currently in a coalition with Berlusconi) could face a lose-lose situation there:

• If the Democratic Party helped vote Berlusconi out of parliament, it could put the government at risk.

• If the Democratic Party voted against the public office ban, it would presumably annoy many of its voters and allow Berlusconi to continue to exert direct influence on Italian politics. It would also provide ammunition to someone like Beppe Grillo, who would instantly claim that 'La Casta' (the caste) has closed ranks to protect Berlusconi. Of course, the Italian Senate going against a Supreme Court ruling would also be a pretty big thing.

Now, we have the joy of waiting for the verdict. Stay tuned @OpenEurope and @LondonerVince.

Q&A: All you need to know about Berlusconi's tax fraud trial and its potential implications for the Italian government

UPDATE (19:20): Supreme Court prosecutor Antonio Mura has just requested that Berlusconi's public office ban be cut to three years. The four-year prison sentence should be upheld, he said.

A very interesting development, although the Supreme Court would obviously be free to uphold the entire five-year ban if it wanted to. As we noted in our blog post from this morning, we will have to wait until tomorrow (or maybe even Thursday) before the final verdict is read out.

OUR ORIGINAL BLOG POST (10:58) 

The final hearing of Silvio Berlusconi's tax fraud case (the so-called 'Mediaset trial') has started in Italy's Supreme Court this morning. However, according to the Italian media, the verdict is likely to be read out tomorrow - or even on Thursday morning.

We thought a short Q&A would help highlight the potential significance of the ruling:

1. Which trial are we talking about? And where are we at?

We are talking about the so-called Mediaset trial, where Berlusconi faces tax fraud charges. The former Italian Prime Minister was found guilty by both the first-instance court and the Court of Appeal. He was sentenced to four years in prison and a five-year ban from holding public office. Therefore, he appealed to the Supreme Court. The Supreme Court is Italy's highest court, meaning that Berlusconi would have no more appeals left if the conviction were upheld.   

2. But he can still be acquitted, right?

Of course. The court can decide to clear Berlusconi completely. Or it can rule that the case must be re-examined by the Court of Appeal. This would increase the likelihood that the tax fraud charges against Berlusconi time out - since Italy's statute of limitations would kick in at some point during the late summer of 2014.

3. What happens if the Supreme Court upholds the conviction? Would the sentence be immediately effective?

No. Berlusconi is a Senator, so he is protected by parliamentary immunity. Therefore, a vote in the Italian Senate's Immunities Committee and a vote in the Senate plenary (most likely through a secret ballot) would be needed before the public office ban can be enforced. Berlusconi's party could be easily outvoted in both cases, but the outcome would be far from guaranteed in reality - not least because Berlusconi's party could threaten to withdraw its support to Prime Minister Enrico Letta's coalition government if the votes go 'the wrong way' from its point of view.

4. Would Berlusconi be likely to spend any time behind bars?

No. If the four-year prison sentence were upheld, three years would be remitted anyway due to an amnesty law passed by Romano Prodi's centre-left government in 2006. This would leave Berlusconi (a 77-year-old man) with only one year to serve - making either house arrest or community service the most likely options.

 5. Okay. Now, let's assume the Supreme Court upholds the tax fraud conviction and the Italian Senate rubber-stamps the public office ban. Berlusconi has to resign and is banned from holding public office for the next five years. What happens to the Italian government?

The short answer is, "Nobody knows". Several senior members of Berlusconi's party have evoked drastic retaliation (withdrawal from government, resignation en masse of Berlusconi's MPs and Senators, snap elections, and so forth). The truth is Il Cavaliere would make the final decision - and his party would then almost certainly follow the leader. Sure enough, there would be the potential to trigger a political crisis in Italy.

6. Could this be the end of the line for Berlusconi's political career?

Not entirely. Even if served with a five-year public office ban, Berlusconi could continue to lead his party - although he would not be allowed to stand for election. 

As usual, we recommend you follow us on Twitter @OpenEurope and @LondonerVince for all the updates from Rome.

Beyond appearances, the recent political crisis has changed things in Portugal

Political stability seems to have returned to Portugal - at least for now. The country's ruling coalition and the opposition Socialist Party have failed to agree on the 'national salvation pact' demanded by President Aníbal Cavaco Silva to help the country successfully complete its EU/IMF bailout programme.

Nonetheless, Cavaco Silva said in a speech yesterday that the continuation of the existing centre-right coalition was "the best [alternative] solution" - thus ruling out snap elections. The Portuguese President also stressed that the government would request a vote of confidence in parliament on its future economic and social policy plans.

So are we back to square one in Portugal? Not entirely.

First of all, there will soon be a cabinet reshuffle - as agreed by the two ruling parties before President Cavaco Silva stepped in. In particular, Paulo Portas - the leader of junior coalition member, the People's Party (CDS-PP) - should become Deputy Prime Minister and be in charge of dealing with the EU/IMF/ECB Troika from now on.

This could be an important change. Let's not forget Portas tendered his resignation from the government because he disagreed with Prime Minister Pedro Passos Coelho over the appointment of Maria Luís Albuquerque as new Finance Minister. On that occasion, Portas made clear that he was hoping for a change in the country's economic policy approach (in substance, less austerity).

This leads to a more general point, which we already made in the past (see here and here). Political consensus around EU-mandated austerity is shrinking in Portugal, and although the turmoil seems to have passed for now, tensions within the ruling coalition will remain - with Prime Minister Passos Coelho's Social Democratic Party (PSD) clearly more in favour of sticking to the current economic policy course than its junior coalition partner.

Furthermore, as Prime Minister Passos Coelho himself admitted this morning, the recent political crisis has "undermined" confidence in Portugal's determination to push ahead with the implementation of its bailout programme - something which could make it more difficult to obtain concessions from the European Commission and its eurozone partners in future.

As we noted in our flash analysis on this issue, these tensions have come at an inopportune moment for the country given that it still needs to enforce significant austerity to meet its targets and that its economic reforms to improve competitiveness now look off track. As political consensus wanes and protests increase, these tasks will become ever more challenging. 

Needless to say, Portugal's return to the markets - currently scheduled for June 2014 - is already looking quite complicated. Further delays or disagreements within the ruling coalition could make things even worse.

Slush fund scandal reignites in Spain, but risk of early elections remains small

UPDATE (16:00): Another interesting fact from the Rajoy-Tusk presser. When a foreign leader comes to Spain on an official visit, the protocol establishes that, at the joint press conference, Spanish journalists and their counterparts from the visitor's country are only allowed two questions each.

Today, it had been agreed that the two questions from the Spanish side would come from El Mundo and the news agency EFE. However, Rajoy unexpectedly gave the floor to a journalist from ABC.

Asked by his colleagues at the end of the presser, the ABC journalist explained that he had received a phone call from his editor dictating him the exact wording of the question he had to put to Rajoy - who then replied by reading a short written statement he had prepared.

UPDATE (15:00): At the joint press conference with his Polish counterpart Donald Tusk, Spanish Prime Minister Mariano Rajoy said, "I'm going to fulfill the mandate I was given by the Spaniards" - a clear indication that he's not planning to resign.

Meanwhile, the first details from Mr Bárcenas's court hearing are emerging. For the first time, he admitted that he was indeed the author of the 'parallel' accounting books published by El País earlier this year (see our blog from last January for further details). Mr Bárcenas reportedly also declared that he made cash payments to Rajoy himself and María Dolores de Cospedal, the Secretary General of Partido Popular, in 2008, 2009 and as recently as March 2010. 

OUR ORIGINAL BLOG POST (11:30)

Remember the slush fund scandal that broke out earlier this year in Spain? Prime Minister Mariano Rajoy and other senior members of the ruling Partido Popular allegedly received illegal cash payments from the party's former treasurer, Luis Bárcenas (in the picture). All these payments were registered in 'parallel' accounting books that were leaked to the Spanish press (see our blog from last January for further details).

After a couple of months of relative calm, the scandal is now reigniting. El Mundo yesterday published several screenshots from Mr Bárcenas's mobile, allegedly showing that Rajoy sent him supportive text messages after the scandal was exposed - the most recent one in March - and asked him to keep calm and deny the existence of the secret accounting books.

Unsurprisingly, the opposition Socialist Party has called for Rajoy to resign "immediately" in light of the latest revelations. Equally unsurprisingly, Rajoy's office denies any wrongdoing and accuses Mr Bárcenas of trying to "deviate attention" from his own judicial problems.

So what happens next? The following points are worth keeping in mind:

• Partido Popular holds an absolute majority in the Spanish parliament, so it looks quite hard for the opposition to force Rajoy out. Indeed, the Spanish Prime Minister could still choose to step down voluntarily or be forced to do so by his own party - but neither option seems to be on the table at the moment;

• Even if Rajoy resigned, he would have the right to indicate his successor - and the King of Spain would have to appoint this person as the new Prime Minister until the end of the current parliamentary term;

• Crucially, the Socialist Party itself has made no mention of early elections so far. They simply want Rajoy to quit and be replaced by someone else from his party. An understandable position, given how badly the Socialist Party is doing in the latest opinion polls.

Therefore, the risk of snap elections remains small for now - although the scandal will inevitably cast a shadow over Rajoy's government, at least until things become clearer.

Today, all eyes in Spain will be on two key events: Mr Bárcenas is due to appear in court, and is expected to provide some more details about the latest events. To add a further twist to the story, his lawyer yesterday said Mr Bárcenas didn't know anything about the publication of his exchange of text messages with Rajoy by El Mundo.

The Spanish Prime Minister is also due to speak in public, in a joint press conference with his Polish counterpart Donald Tusk - which is also going to be interesting. We will keep a close eye on anything coming from Spain throughout the day, so keep following us on Twitter @OpenEurope and @LondonerVince.

Is Italy already heading for fresh political uncertainty?

Last month, we wrote on this blog that Silvio Berlusconi's well-known 'Ruby trial' posed no immediate threat to the stability of Italy's coalition government. Instead, we noted, the real risk was the less titillating 'Mediaset trial' - where Berlusconi is accused of tax fraud and could be banned from holding public office for five years.

Recent events seem to prove us right. Italy's Supreme Court has announced that it will issue the final verdict in the tax fraud trial on 30 July - much earlier than expected. The announcement has triggered a huge backlash from Il Cavaliere's camp and is showing once again just how fragile Italy's coalition government is.

Berlusconi's party wants to suspend all parliamentary activities for three days in protest against the Supreme Court's decision, or it will pull out of the coalition - which would deprive Enrico Letta's government of its majority in parliament and potentially make snap elections a real prospect.

The impression is that, even if this immediate threat were turned down, the survival of the Italian government may be put in doubt again shortly should the Supreme Court uphold the five-year public office ban for Berlusconi - making it definitive.

In the meantime, Standard & Poor's yesterday cut Italy's credit rating by one notch to BBB, leaving it on a negative outlook and only a few notches above 'junk' level, citing concerns over economic output growth as a key reason for the decision. A gentle reminder that the country remains under market surveillance and the way out of the woods is still quite long.

A bad time to trigger a fresh political crisis.      

Portugal's Finance Minister quits: A bolt out of the blue? Not really...

A surprise development in Portugal this afternoon, as Finance Minister Vítor Gaspar has announced his resignation. The office of Portuguese President Aníbal Cavaco Silva has said in a note that Gaspar will be replaced by Maria Luís Albuquerque - one of his deputies, with a long career in the Portuguese Treasury.  

Initially, the news sounded very much as a bolt out of the blue. That was until Jornal de Negócios published Gaspar's letter of resignation on its website. The letter reveals the following:

• Gaspar had already written to Portuguese Prime Minister Pedro Passos-Coelho in October 2012, stressing "the urgency of [his] replacement as Finance Minister."

• At the time, Gaspar had decided to quit over "a series of important events". In particular, he mentions the Constitutional Court ruling that struck down the government's plan to limit extra holiday and Christmas pay for public sector workers as unconstitutional in July 2012, and "the significant erosion of public support" for the austerity measures attached to the Portuguese bailout.

• However, Gaspar was asked to stick around a bit more - at least until the 7th review of the Portuguese bailout by the EU/IMF/ECB Troika was finalised and an extension of the bailout loan maturities was secured. Incidentally, the fact he has now been allowed to leave could be seen as a vote of confidence from the government in the strength of the Portuguese economy (although Gaspar may simply have been stepping up the pressure to be allowed to exit).

• Gaspar also points out that Portugal's consistent failure to meet its deficit and debt targets under the EU/IMF bailout agreement had "undermined [his] credibility as Finance Minister." On this point, it is probably worth reminding that, on Friday, it came out that Portugal's public deficit in the first quarter of 2013 had reached 10.6% of GDP - with the target for this year set at 5.5% of GDP.

• Interestingly, Gaspar concludes his letter by saying, "It's my firm conviction that my exit will contribute to reinforce your [Prime Minister Passos-Coelho's] leadership and the cohesion of the cabinet". This seems to suggest Gaspar may have lost faith in the reform approach taken in Portugal, and may not have been willing to push ahead with it (not least for the reasons mentioned above).

In any case, the news of Gaspar's resignation hardly comes at a great time for Portugal. As we noted in a recent briefing, the country faces some tough challenges this year:

• Domestic demand, government spending and investment are contracting sharply, leaving the country heavily reliant on uncertain export growth to drive the economy. 

• By cutting wages and costs at home (internal devaluation), Portugal has in recent years improved its level of competitiveness in the eurozone relative to Germany. However, this trend actually started to reverse sharply in 2012, meaning that the divergence between countries such as Portugal and Germany has begun growing again – exactly the sort of imbalance the eurozone is seeking to close. 

• In its austerity efforts, Portugal is now coming up against serious political and constitutional limits. For the second time, the country’s constitutional court has ruled against public sector wage cuts – a key plank in the country’s EU-mandated austerity plan – while the previous political consensus in the parliament for austerity has evaporated. 

How much impact this will have remains to be seen, although in a country where the economic future remains uncertain, suprises such as this are hardly ever welcome. In practice, though, the approach is likely to continue in much the same vein, firstly because the EU/IMF/ECB Troika has shown little willingness to be flexible with Portugal, and secondly because Maria Luís Albuquerque has often voiced her support for the approach taken so far.

That said, it is an interesting reminder of the strains the bailout programme is putting on the Portuguese government, as it begins the difficult task of finding a way to smoothly exit from its reliance on external funding.

Could Berlusconi's trials put the Italian government at risk? Not immediately, but...

The news didn't exactly go unnoticed in the media across Europe, but just in case: Italy's former Prime Minister Silvio Berlusconi has been sentenced to seven years in prison and a lifetime ban from holding public office in the well-known 'Ruby trial'. The usual caveats apply:

• The sentence is not immediately effective, because Berlusconi has the right to two further appeals. Given that it took 26 months to get to yesterday's ruling, the trial will not be concluded anytime soon;

• Berlusconi will turn 77 in September, meaning that he is unlikely to serve any time in prison anyway because of his age.

Clearly, the big question is what impact Berlusconi's trials could have on the stability of Italy's coalition government - whose survival depends on support from his PdL party. The short answer is: no-one knows.

So far, Berlusconi has consistently stressed that these are two separate issues, and his "loyal support" for Prime Minister Enrico Letta will not be affected by the outcome of his trials. However, caution is needed for one very simple reason. Berlusconi may be playing the responsible statesman right now, but this is in part because none of the rulings against him are definitive, yet.

Remember Berlusconi is facing several different trials at the moment. One of them (the Mediaset trial, where he is accused of tax fraud) is drawing to a conclusion, with the final verdict from Italy's Supreme Court expected by the end of the year, or in early 2014 at the latest.

If the Supreme Court were to upheld the previous two rulings, Berlusconi would face a four-year prison sentence and a five-year public office ban - which would virtually mark the end of his political career. At that point, the consequences for the Italian government would really be unpredictable. A key member of Berlusconi's party, Senator Maurizio Gasparri, even suggested that, if the former Italian Prime Minister were issued with a definitive public office ban, all his MPs and Senators could resign en bloc.

Berlusconi will meet Prime Minister Letta this evening. In theory, the meeting should focus on this week's EU summit - but the ruling will almost inevitably be discussed as well. We will keep you posted about any interesting developments via Twitter @OpenEurope. 

The show(down) must go on: Coalition row over closure of Greece's public broadcaster continues

Last week, we noted on this blog that the abrupt closure of Greece's public broadcaster ERT risked opening a rift in Greece's ruling coalition - as Prime Minister Antonis Samaras took the decision without the approval of his junior coalition partners, PASOK and Democratic Left.

Tensions have actually mounted within the coalition, and all eyes are now on a meeting later on today between Samaras, Evangelos Venizelos and Fotis Kouvelis (the leaders of PASOK and Democratic Left respectively). Here's a quick update of what happened over the weekend:

• After both PASOK and Democratic Left hinted at snap elections as a possible outcome of the on-going coalition row over ERT, Samaras came up with a compromise proposal: have a cross-party committee hire a small number of workers so that a basic broadcast service (mainly news bulletins) could resume as soon as possible;

• Samaras's coalition partners have both turned the offer down. They concede ERT needs restructuring, but want the state broadcaster to stay open while such a restructuring takes place;

• This makes today's meeting (scheduled for 5.30pm GMT) very interesting. Venizelos and Kouvelis are apparently not planning to make doorstep statements after the meeting with Samaras, but will wait to speak until they are back at their respective party headquarters - possibly another sign that tensions are running high;   

• German Chancellor Angela Merkel yesterday spoke to Samaras over the phone and reminded him that "it is of vital importance" for Greece to stick to all its commitments with the EU-IMF-ECB Troika, including "those relating to public sector reform." Just a coincidence? Or an invite to Samaras to stick to his guns on ERT closure? 

• Meanwhile, Alexis Tsipras, the leader of the largest opposition party, SYRIZA, is to deliver a speech in Syntagma Square this evening - right in front of the Greek parliament. No doubt he will use it to call for the government to resign.

• Finally, it's worth keeping in mind that ERT workers have appealed to the Council of State - Greece's highest administrative court. The Council of State should issue its verdict later on today, and many expect it to order that ERT be immediately re-opened. Paradoxically, the ruling could help put an end to the coalition row. However, it would almost inevitably also weaken Samaras's position - given that his initial decision to shut down ERT would be overturned.  

We will keep a close eye on any future developments, so make sure you follow us on Twitter @OpenEurope if you want to stay on top of the latest events in Greece.   

Mervyn King on the solutions to the eurozone crisis

The FT has just posted an interesting and lengthy interview with outgoing Bank of England Governor Mervyn King (pictured), conducted by the FT’s Martin Wolf. Many pressing topics are covered but the short discussion about the eurozone caught our eye (as might be expected).

When asked about the solutions to the eurozone crisis, King sums up the options very succinctly and without the usual qualifying statements needed by those directly involved in the crisis:

 “I think there are four [solutions]. One is to continue with mass unemployment in the south, in order to depress wages and prices until they’ve become competitive again. The second is to say, ‘Well, we have to get rid of this imbalance in competitiveness, so we need inflation in Germany.’ That seems unattractive, certainly to the Germans.

“The third is to give up on this question of restoring competitiveness quickly and accept that this is an indefinite transfer union. That requires two things: one is for people in the north to give money to people in the south; the other is for people in the south to accept the conditions imposed on them, which will limit the size of the transfer.

“The fourth is to change the membership. Now, I don’t know what the right answer is, and it will depend on their political objectives, but economics tells you that you have to have one or some combination of these.”

A very concise and accurate summary we’d say. Obviously each option can be tinkered and altered but the broad truth is all there.

However, we might go so far as to narrow the options down even further. Option one (which is currently being employed) seems unlikely to be politically or socially acceptable – countries such as Greece, Portugal and Cyprus in particular would struggle to regain competitiveness this way. It would also leave the structural flaws of the eurozone untouched, leaving it incredibly vulnerable to future crises.

Option two also seems unlikely to be sufficient, even if it were an option politically. We would say some element of it is probably necessary for the eurozone, but far from sufficient to solve the crisis. It could also create the ‘uncompetitive union’ which Germany fears most, as although internal imbalances in the eurozone may be eased the actual competitiveness of the bloc as a whole would be much worse than previously. There are also questions about how much such an approach would spillover into growth in the struggling eurozone countries - as we discussed in detail here. Again it also does not tackle the institutional flaws.

Therefore that leaves us with options three and four – something we have noted before.

Before the crisis can ever be solved the true choices facing the eurozone need to be realised. Let us hope that this weekend some of the eurozone leaders read King’s interview.

Will the closure of public broadcaster set the scene for a coalition showdown in Greece?

Imagine a Number 10 spokesperson announcing during the afternoon news bulletin that the BBC has become too expensive to run and will be shut down with immediate effect. You would be excused for thinking that the Government and the Corporation have joined efforts to take you for a ride.

Well, this is exactly what happened in Greece - and it wasn't a joke. Greek government spokesman Simos Kedikoglou went on TV yesterday afternoon to say that the country's public broadcaster ERT would go off the air a few hours later, because it had become a "refuge of poor transparency and waste."

As a result, ERT's almost 3,000 employees have been temporarily laid off. The Greek government says that a revamped and slimmed-down broadcaster (NERIT SA) will be up and running by the end of August. Protests were staged outside ERT's headquarters yesterday and are continuing today, while ERT journalists are still putting programmes on air via digital frequencies and the internet.

A couple of points are worth making at this stage:

• The decision to shut down ERT is clearly linked to Greece's commitment to firing 15,000 public sector workers by the end of next year under its EU-IMF bailout deal, although it's up to the Greek government to choose where to cut. Therefore, it's probably not entirely fair to blame the Troika for this (admittedly pretty extraordinary) decision;

• The fact that the Greek government prefers shutting down ERT altogether and then opening a brand-new company, instead of trimming the existing company down, could be seen as further evidence of how difficult it is to fire public sector workers in Greece - even in cases where inefficiency and waste are evident (at least according to what the Greek government spokesman said);

• On the domestic politics front, Greek Prime Minister Antonis Samaras has decided to go ahead with the closure of ERT despite open opposition from his coalition partners - PASOK and Democratic Left. The latter now want to submit a draft bill to scrap the decision, meaning that there is a risk of a coalition split - unless someone blinks.  

As the Troika has long suggested, it is clear that Greece's bloated public sector needs to be downsized significantly. That said, it is also clear that this situation has been poorly handled, particularly given the wider political and social tensions already at play in the country. The fallout of this story might be worrying - further splits in the governing coalition and wider public backlash against an austerity programme for which there is already very little buy-in.

We will keep monitoring the situation and give further updates on Twitter @OpenEurope.

Berlusconi wants to say 'basta' to EU diktats

Silvio Berlusconi's interviews never go unnoticed. Yesterday evening, he told Italian TV channel T9 that:

"We now have a strong government…also vis-à-vis Europe. We need this government to go to Brussels and say ‘I’ll do it this way’. We can no longer accept certain diktats. It’s for us to decide what needs to be done to put our economy back on its feet." 

Our regular readers know this is not the first time Berlusconi uses this type of rhetoric (see here and here for similar remarks). But his words have a much greater significance now. The electoral campaign is over, and Berlusconi's party holds a number of key ministerial posts in the new Italian government - on which he can pull the plug whenever he likes.

As we noted before, Berlusconi's blackmailing power could lead to Italy taking a tougher anti-austerity stance in Brussels - and this is exactly what Il Cavaliere is trying to achieve. Pressure is now on Italian Prime Minister Enrico Letta, who has so far been a lot milder in his demands for an easing of austerity and has consistently stressed that Italy will stick to its EU commitments.

Letta can't ignore Berlusconi's requests, or the survival of his 'grand coalition' will be at risk. But he will also have to make these requests sound acceptable to German Chancellor Angela Merkel - who faces a general election in three months' time. Not the easiest of tasks.