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Renzi had promised to resign if defeated, and the overwhelming vote against him left him little choice. An hour after the size of his defeat became known Renzi announced he would resign as of Monday morning. There had been some speculation that Renzi would stay on as a caretaker prime minister, but it now seems clear that either a “technocratic” government will be installed or a center-right coalition of parties will form a transitional government with early elections likely.

The referendum coincided with Italian government efforts to avert a crisis in Italy’s banking sector, where roughly a fifth of all loans are in some stage of default. Italian bank stocks have lost almost two-thirds of their value in the past year. That is worrying because Italian banks own more than a fifth of Italy’s more than US$2 trillion of sovereign debt. The banks have been bailing out the government while the government is supposed to bail out the banks.

That has led some observes to warn of a financial crisis if Renzi’s reforms were rejected. There are two possible detonators for a crisis. First, the market could refuse to fund Italian banks in the wholesale market, forcing the European Central Bank to support them with temporary loans without restoring confidence. Second, the yield on Italian government debt could rise sharply, ballooning Italy’s budget deficit. Italy’s deficit now stands at -2.6% of GDP. With government debt at 130% of GDP, a 2 percentage point increase in Italy’s bond yield would double the deficit, leading to more upward pressure on bond yields in a vicious cycle.

Renzi had promised to resign if defeated, and the overwhelming vote against him left him little choice. An hour after the size of his defeat became known Renzi announced he would resign as of Monday morning. There had been some speculation that Renzi would stay on as a caretaker prime minister, but it now seems clear that either a “technocratic” government will be installed or a center-right coalition of parties will form a transitional government with early elections likely.

The referendum coincided with Italian government efforts to avert a crisis in Italy’s banking sector, where roughly a fifth of all loans are in some stage of default. Italian bank stocks have lost almost two-thirds of their value in the past year. That is worrying because Italian banks own more than a fifth of Italy’s more than US$2 trillion of sovereign debt. The banks have been bailing out the government while the government is supposed to bail out the banks.

That has led some observes to warn of a financial crisis if Renzi’s reforms were rejected. There are two possible detonators for a crisis. First, the market could refuse to fund Italian banks in the wholesale market, forcing the European Central Bank to support them with temporary loans without restoring confidence. Second, the yield on Italian government debt could rise sharply, ballooning Italy’s budget deficit. Italy’s deficit now stands at -2.6% of GDP. With government debt at 130% of GDP, a 2 percentage point increase in Italy’s bond yield would double the deficit, leading to more upward pressure on bond yields in a vicious cycle.

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