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Is Italy Heading for Default?


Any potential partial writedown of Italian sovereign debt will dwarf the effect of a Greece writedown.

Editor's Note: The following was posted in real time on our premium Buzz & Banter (click for a free trial).

Back on Sunday posted the below chart from Bloomberg, which may or may have not reposted it from another source.

There are three important features to this chart. Probably the least important is the vertical scale although that has the potential to bite some institutions or hedge funds big-time. The bubbles are the size of sovereign debt by European countries. Big is bad, further right is even worse. Obviously, Greece is overleveraged and is paying the price for it now. The giant meteor in the sky is Italy. The size of the meteor is $1.8 trillion dollars of sovereign debt. Roughly 25% of this needs to be refinanced in the next 18 months.

The vertical scale is the amount of Credit Default Swaps (CDS) written by analysts that positively, absolutely told their investment committees that there was no way Italy could possibly default. Luckily, it would appear that the amount is much smaller than the folks at AIG (AIG) that positively, absolutely guaranteed subprime tranches that would never default. Nevertheless, any potential partial writedown of Italian sovereign debt will dwarf the effect of a Greece writedown. The stakes in Europe are high and nothing seems to have a reasonable chance of an easy mitigation.

So all you hedge fund and institutional money managers... you think you can take a vacation this summer? No debt ceiling solution? Sure you say, "That will be finalized a day before my Hampton rental starts August 1." Positively, absolutely? Folks, you better be flat or hedged. The next eight weeks until Labor Day do not have the looks of a quiet summer.

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