Within 24 hours after Italy’s pivotal confidence vote, Prime Minister Silvio Berlusconi ceded his power and announced his intentions to resign – following the passage of several financial reforms laws.  The news helped the EURUSD gain on the session, as well as other major currencies like the Australian dollar and British pound.  But, Berlusconi is the least of the country’s problems and the situation surrounding Italy and its financial crisis are far from over.

The removal of Berlusconi places the country’s government and political stance in the jeopardy.  Although there are strong candidates from parties that were previously linked with the premier – ie the Northern League headed by Umberto Bossi – , they will likely meet competition from opposition forces, like the center minded Third Pole or Democratic Party, seeking the same seat.  Although this could mean snap elections in the beginning of 2012, it could also mean politicians could wait till the end of the electoral term in 2013.  Either way, the indecision caused by a potentially leaderless government could compound already depleting confidence by the global investor community.

And then there’s the debt problem.

Aside from the staggering size of the country’s debt market (approximately 130% of GDP), the current government will have to deal with financing such a behemoth sum.  And, with currently bearish sentiment being focused on the country’s bonds, the issue is likely to get worse.

Recently, the country’s yield curve has become inverted – making the yields of shorter term bonds higher than longer term bonds.  This is because market traders have recently sold off their positions in 2 or 5 year Italian bonds while buying up longer term 30 year debt.  The phenomenon is usually associated with severe recession as yields are reflective of the view that rates will remain low well into the future on lower economic growth.  This sentiment has caused the benchmark 10-year yield to skyrocket to above 7%.  Government and global economic officials have both agreed that this is a dangerously high level as it would make financing costs for the country too high to maintain – increasing the likelihood that the country will default on its debt.

The situation becomes worse as local and international clearing houses have begun increasing initial margin requirements to hold and trade these bonds.  Most recently, clearinghouse LCH Clearnet increased mandatory margin costs at almost 12%, double the rate quoted just one month ago.  Raised margin requirements will do nothing but increase the cost of holdings by global investors supporting a higher likelihood that additional positions will be liquidated in the market – once again lower bond prices and increasing bond yields.  The longer the debacle goes on, the higher the likelihood that no clearing house or counterparty will want to deal with the Italian government and their ostracized debt.

So, yes, Berlusconi’s leave does take some temporary pressure off of the Euro.  But, given a directionless government, skyrocketing debt financing costs and falling investor confidence in the country, it seems that the premier is the least of the country’s laundry list of problems.