Europe’s Critical Weekend

During the 2008 credit crisis, U.S. regulators worked weekends to make certain that negative news about the nation’s banking system could be offset by policy decisions before Asian markets opened Monday. Financiers tried similar tactics after a market collapse on Friday, October 16, 1987. It did not work in that case. The following Monday became known as Black Monday. The DJIA dropped 22.61% that day.

Now it is Europe’s turn to radically change the perception of its finances before the stock markets around the world open next Monday. Greece has a new prime minister — Lucas Papademos. He will form an emergency coalition cabinet over the next two days. But the new government is one without any new solutions. At least, that is what the market believes.

Mario Monti likely will be elected as the new prime minister of Italy on Monday. In the meantime, he will try to lead a vote by the nation’s parliament to set new austerity measures that its EU neighbors and capital markets investors will accept. Without that acceptance, Italy’s borrowing costs could remain above an unsustainable 7%.

The public pressure on Italy has increased sharply in just the past day. Economist Nouriel Roubini believes that the only way to save the euro is for Italy to quit the union. “To resolve the latter, Italy may, like other periphery countries, need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone,” Roubini said in the Financial Times.

An Italian decision to drop out of the union probably would destroy any economic recovery it might hope for over the next two or three years. Its ability to borrow would disappear entirely. That would prompt the government to adopt austerity programs that have not even been imagined yet. Italy is the third largest economy in Europe. The effects of a depression on the rest of the region are incalculable.

The capital markets have been unusually patient. Global indexes have sold off as much as 3% to 4% in a day recently when concerns about the eurozone’s survival spike. But those markets often rebound the next day. If resolutions to the problems of Italy and Greece are not made soon, and made in a way that investors believe is acceptable, the markets will dive and not recover, perhaps for months.

The situation in Europe has reached a tipping point. Investors grow more nervous by the day. As trading closes in the U.S. today and anxiety remains high, the weekend could begin a panic that will spread when markets around the world open on Monday.

Douglas A. McIntyre