As news spread that the famous writer Mark Twain had passed away, in 1897 a reporter went to his home to ask for information. The writer welcomed him in person saying: "The reports of my death were exaggerated." Italy must do the same today in the face of the further downgrading that Moody's inflicted on it by lowering the rating on the Italian public debt by two notches, from A3 to Baa2.
It is useful to remember that, on the Moody's scale, the highest rating of AAA goes down to the lowest of C. The Baa2 rating level is more or less halfway between the maximum and the minimum. However, there is a however: when the rating drops to B1, it drops from the "investment grade" segment (which goes from AAA to Baa3 inclusive) to the "under-investment grade" segment (which goes from B1 to C) . Falling into the under-investment grade (sometimes referred to as junk) segment is not a good thing because it means investors would normally require much higher interest rates to underwrite our securities. And those higher interest rates would imply further needs to raise taxes or cut government spending. In short, we have not yet reached Baa3, the critical threshold between investment and under-investment, but we are very close.
So why is it the case to respond as Mark Twain did, remaining firmly convinced that there will be no default of the Italian public debt? There are two good underlying reasons. First, rating agencies are often wrong. It would suffice to recall that Moody's (together with its sister companies S&P's and Fitch) had not seen the crisis coming to East Asia in 1997, had not noticed the rigged accounts of Enron, Parmalat and many other companies that defrauded investors in the season of mega- corporate bankruptcies (2001-02), he hadn't noticed that Lehman Brothers was about to jump … and many more cases could be added. In all of these cases, investors who had trusted the ratings of the three global giants of the rating industry realized huge losses. In the case of the European sovereign debt crisis, then, the problem is that of a political crisis and not of bad macroeconomic fundamentals. As the Governor of the Bank of Italy recalled on 31 May in his Final Remarks, the Eurozone is a balanced area "more than other advanced areas of the world" (read: Japan and the USA) and its "good" economic fundamentals are put at the mercy of speculation only by the weakness of its political fundamentals. So, what do the rating agencies know about the decision-making processes of the European chancelleries? Unless they have the crystal ball, they know as much as we do. So if their judgments on individual private companies are to be taken with a grain of salt, even more so are those that the rating agencies issue today on European sovereign debt. This means that investors will have to equip themselves to rely less and less on the judgments of the agencies. And it is no coincidence that the President of the European Central Bank, Mario Draghi, also spoke in this way, and, in fact, the central bank that he directs has lowered the rating threshold of the securities that it accepts as collateral when it gives liquidity to commercial banks, neutralizing thus the downgrades ordered by the rating agencies.
The second reason why we must remain calm is that, even if everything were to go badly for the euro and we were forced to return to the beloved lira, Italy would still not fail. Indeed, returning to the lira, probably at a parity devalued by about half compared to the one with which we entered the euro, we would have a temporary economic recovery which for a few years would do us great good and which, therefore, would also allow us to bring back more easily secure the public debt problem. Having said that, I can only continue to avert the scenario of the dissolution of the euro because the long-term costs would be disproportionate for all of us and for our children and grandchildren. Abandoning the euro would mean abandoning the European Union as we know it to venture down an uncharted path that could generate conflicts and, even if it did not, would weaken Europe just as the American protective umbrella takes on water and the Western world appears increasingly at the mercy of China and other major emerging economies.
Therefore, in all probability, by downgrading Italy and bringing its public debt close to the junk bond threshold, Moody's is wrong. And maybe he even knows he's wrong. As the wise man said, in these conditions we shouldn't get excited but we need to keep a cool head and demonstrate with facts the mistake of those who are hurting us. The first response was not bad: on Friday the auction of 3-year BTPs recorded a sharp decline, with interest rates down to 4,65% from 5,30% in the analogous auction in June, the lowest since May; moreover, the Stock Exchange has a positive sign. In short, the market seems to ignore the downgrade of the Italian rating decided by Moody's.
