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The Italian Chamber of Deputies will vote on a minor formality regarding last year's budget report on Tuesday around 14:30 GMT (9:30 EDT), but it holds within it the potential to topple the second eurozone prime minister in less than a week.

Greek Prime Minister Papandreou has stepped down in favor of a national unity government which has yet to be named. If Italy's ruling coalition does not secure a simple majority in the 630-seat chamber, the Berlusconi government will collapse. Last month, a confidence vote, which is a parliamentary tactic used to enforce discipline, just passed with the minimum of 316 votes.

However, in recent days, three MPs have defected and another six have openly called for Berlusconi's resignation. It is not clear that Berlusconi can pull it off or at what cost. If he fails, the opposition has reportedly indicated that it is prepared to call for a vote of no-confidence. This is a parliamentary tactic used to see if the government still holds a majority in parliament.

Last December, they failed to bring down Berlusconi with the same tactic. Not only has he lost MPs, but some of his important allies, like the employers' association, appear to have abandoned him. His public support is low and falling.

Berlucsoni is also weak internationally, where he has reportedly been lectured by Merkel and Sarkozy, who do not appear to take him seriously. He has "invited" IMF monitors into the country to monitor implementation of austerity measures that were part of the pre-condition of the ECB buying Italian bonds in early August.

The quid pro quo of austerity for bond purchases is brings to mind the old USSR joke about how the government pretends to pay the workers and the workers pretend to work. Neither side appears to be in good faith. The Greek budget deficit is bigger in the first three quarters of the year than it was last year. The ECB, under Trichet and now Draghi, is not comfortable buying sovereign bonds as it is perceived to erode the central bank's independence and blur the distinction of monetary and fiscal policy. The compromise between ideological constraints and the dictates of necessity is to purchase small amounts.

The ECB has stepped up its bond purchases in the most recent weekly data. However, the size is miserly at about 9 billion euros, though that's more than the previous two weeks put together. Italy's bond market is bigger than the bond markets of the other periphery combined (Spain, Ireland, Greece and Portugal). If the Italian bond market does not stabilize quickly, the risk is the clearers will require greater margin and this could spur a dangerous spiral, as it has in the recent past.

The halfhearted purchase of a modest amount of Greek, Irish and Portuguese bonds did not arrest the rise in yields. It will not do so for Italy. ECB purchases do allow some private sector investors to lighten their loads. Yet as we have learned in Greece, the more the ECB buys, the greater the private sector haircut that will be required to bring the debt overhang to manageable levels.

If the Berlusconi government fails, the first choice would likely be to see if a new government can be formed with the existing parliament. A technocratic government could emerge and its mission would be to approve and implement the program that Berlusconi already agreed to. The technocratic government could last through next year and prepare for elections when the parliamentary term ends in 2013.

Alternatively, new elections could be called. This would only compound investor uncertainty and make it more difficult for Italy to raise the tens of billions of euros in the remaining five bonds auctions this year. It would likely be more euro negative than the technocrat government.

Ironically, the end of the Papandreou and Berlusconi governments would complete the re-shuffle. All five of the peripheral countries would have new governments. Ironically, Spain's Zapatero might be the last to go as Spain goes to elections, which were brought forward and slated for November 20. In the end, the austerity agenda is carrying the day.

Assuming that the Greek and Italian political situations stabilize, the focus may shift back to the Iberian peninsula. The risk is that the new Spanish government will report a larger budget deficit and weaker finances in general than the outgoing government has recognized. Spain has three bond and four bill auctions before year-end.

Portugal needs to approve the 2012 budget and this will require acknowledgement that it is missing this year's targets. While the eurozone as a whole only now looks to be entering a recession, the Portuguese economy contracted in both Q1 and Q2 and is likely to have contracted in Q3, when the preliminary data is reported on November 14. The Portuguese economy contracted in 2008 and 2009 before expanding last year. This year the contraction has resumed. The consensus forecasts calls for continued contraction in 2012 and 2013.

Such a bleak economic outlook does not appear conducive to political stability, let alone stabilizing the debt situation and reassuring investors. If investors have been asked to "voluntarily" asked to forgive half of what Greece owes and accept a lower coupon, what will private sector investors in Portugal be asked to forgive?

Disclosure: No positions

Source: Will Italy's Political Drama End Tuesday?