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The Italian Crisis

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August 3, 2016

Italy is facing its greatest financial crisis in the post-war era. The country’s banking system is bankrupt and no one in Europe seems willing (or able) to fix it. Since 2009 Italian bad debts have multiplied from less than 3% of total loans to more than 18% today. As a result, many Italian banks have far more bad debts than they have capital to back them up.

To put that into better focus, banking regulators generally begin to worry when banks’ non-performing loans reach 5% of the bank’s assets. In Spain, for example, during the height of their housing bubble burst in 2010 (when the whole country appeared bankrupt) non-performing loans never went much above 10%.

In Italy today the total value of non-performing loans is an unprecedented 18% of assets. Italy now has the biggest concentration of weak large banks in the world; nine institutions in all. Moreover, five of Italy’s nine weakest global banks are megabanks, each with over $100 billion in assets:

  • Unione di Banche Italiane, with $132.8 billion in assets;
  • Banco Popolare SC, with $139 billion;
  • Banca Monte del Paschi di Siena (the oldest bank in the world), with $197.6 billion;
  • Intesa Sanpaolo, with $796.9 billion; and
  • the largest of all, UniCredit SpA, with over $1 trillion.
In theory, the solution to any banking crisis is essentially straightforward: You bankrupt the shareholders and the bondholders and then you recapitalize the banks. According to most estimates, Italy would need about $40 billion to get the job done; a large but still manageable number.


There is, however, one very nasty glitch to this ‘simple’ plan. In Italy, the bonds of these banks are not owned by institutions but by very many small retail investors. According to Bank of America Merrill Lynch, small investors own 235.6 billion euros of bank bonds and the banks do not want to panic them (with all the civil unrest and social deprivation that would bring in its wake).

To make matters worse, Italy also has more public debt than any other EU member except Greece whilst having an economy that is nine times larger than that of Greece. In a full-blown banking crisis, not only would Rome be hard pressed to come to the rescue but Brussels and the EU would have a tough time saving Rome.

So we find ourselves in a standoff. German Chancellor Angela Merkel (and even the Italian-born head of the European Central Bank, Mario Draghi) refuse to budge on this issue and will not bail out the Italian retail bondholders. Italy’s technocratic Prime Minister Matteo Renzi (put in place by the EU itself) is desperately trying to reason with them but, thus far, the talks are at a standstill. If Italy is forced to do a “bail-in” (which is banker’s terminology for bankrupting the bondholders) then the political and social backlash could tear Europe apart.

Italy already faces a very strong independence movement in the Five Star party and it has been winning local elections at a rampant rate. If Merkel and Draghi force Renzi to effectively wipe out 15% of the country’s wealth as a result of bank recapitalization then the backlash will be huge.

Italy is the third-largest economy in the Eurozone and if it goes then the eurozone will probably crumble soon thereafter. If the all the parties concerned can’t come to a practical agreement soon then the situation will go from bad to worse. The euro will come under increasing pressure and the political crisis in Italy along with the collapse of their banking system will most probably result in Italy leaving the EU. The EU will then collapse.

The EU project in its current form and with its deliberately anti-democratic aim of creating a Federal Europe will ultimately be a failure of epic proportion and we predict its demise by 2021. Perhaps then (if not before) we can return to the original concept of a pan-European free trade area without all the federal baggage. For those who still harbour lingering doubts about the very positive benefits of Brexit, the Italian crisis and its likely denouement would strongly suggest that the UK has dodged a bullet.

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