AMERICAN.COM

AEI’s own Daniel Hanson opines thusly:

Moody’s downgrade of Italian credit late Tuesday afternoon for the first time in two decades will likely once again draw the ire of officials in the Eurozone who continue to insist they have the capabilities to cope with Europe’s growing debt problems despite overwhelming evidence to the contrary. In reality, the downgrade was a long time coming.

Italy approved a €54 billion austerity package this month, causing bond yields to drop by about 100 basis points as the European Central Bank began purchasing Italian debt. Despite this, Italy’s borrowing costs remain near record highs, and the cost of insuring Italian debt is more than twice what it was at the start of the year. Additionally, Italy’s economy remains stagnant with real year-over-year GDP growth hovering below one percent in the first half of 2011. While Italy might have succeeded in finding the political will to make real spending cuts, without growth, the Italian budget will not be balanced any time soon.

Indeed, with net government debt over 100 percent of GDP, Italy’s path is clearly unsustainable. The markets have sensed trouble and have accordingly priced in a default. The added exacerbation caused by fears of contagion from the other diseased countries in Europe has pushed investors to demand higher compensation to hold on to Italian bonds. Most of the media attention has been fixated on Greece’s fiscal troubles in recent weeks, but the other troubled countries of southern Europe – Italy, Spain, and Portugal – have been in the back of investor’s minds.

The reason is simple: the European Financial Stability Facility (EFSF) has adequate funding to bail out a smaller economy like Greece, but a default by a larger economy would be catastrophic. The €440 billion in the EFSF pale in comparison to the roughly €800 billion in bad debt owed by the bankrupt economies of southern Europe before the end of 2013. Moody’s may have been late downgrading Italy’s creditworthiness, but they’ve finally realized what the markets have been saying: Italy might be too big to fail, but for Europe, it is also too big to save.