John Browne
On December 7, 2016, Italy’s Prime Minister Matteo Renzi resigned
following defeat in a national referendum, that he had supported, that
would have changed the country’s parliamentary system. The development,
which represents just the latest sign of anti-EU sentiment spreading
throughout Europe, was felt acutely by Italy’s troubled banking sector.
In particular, the Banca Monte dei Paschi di Siena (MdP) has been
teetering on the brink of collapse and now may stand as a case study
that may be encountered by other EU member nations.
The advent of the euro currency allowed Eurozone member countries,
even those with poor financial health like Italy, to borrow at far lower
‘Germanic’ interest rates than their respective national credit ratings
would have allowed. In turn, national borrowers were able to tap into
the vast sums of liquidity created under central bank quantitative
easing (QE) programs at astonishingly low, and sometimes negative,
interest rates. Predictably this has led to a massive misallocation of
capital, and billions in potentially non-performing loans.
The problem for Italian banks became particularly acute when the
fall of the Renzi government raised the possibility that a new
Government could seek to lead Italy out of the Union and bring back the
lira to Italy. With the return of its own currency, future Italian
governments could devalue at will in order to pay the country’smounting
debts. If faced with the possibility that their euro-denominated
deposits could be transformed into shrinking lira deposits some could be
convinced to transfer funds into German banks where they would face no
such peril (EU laws present no obstacles to cross-border banking). This
is a clear recipe for a banking default.
According to a 2016 IMF working paper (WP16135), Italian bank
nonperforming loans had tripled since the crisis of 2008. It blamed “A
combination of over-indebted corporates following the sharp
crisis-related drop in output, banks generally low in capital buffers, a
highly complex legal system of corporate restructuring and insolvency,
lengthy judicial processes and a tax system that until recently
discouraged NPL write-offs … .” On September 13th, Bloomberg estimated
Italy’s nonperforming loans at $394 billion through March or 16.1
percent of Europe’s total, based on data from the European Central Bank
(ECB).
Furthermore, a relative lack of economic opportunity and a massive
increase in inward migration has caused a marked increase in emigration
from Italy, particularly among young males. The recently released OECD
2016 International Migration Outlook recognizes that, “The public is
losing faith in the capacity of governments to manage
migration.” Italian emigration more than doubled between 2010 and 2014.
This contributed to an erosion of the bank deposit base.
Italy is one of the world’s most indebted nations with debts
estimated in 2015 at over $2.4 trillion or 130 percent of its GDP, about
half of which is comprised of government spending. Therefore, Italy is
not well placed to finance a potentially devastating and fast developing
domestic banking crisis.
In the U.S. banking crisis of 2007/8, our government reacted
quickly to a potential international financial meltdown by organizing
the Troubled Asset Relief Program (TARP) to purchase ‘toxic’ assets from
banks bailed-out with taxpayer funds. Politically, it was highly
unpopular. In Europe’s case, influenced largely by Germany’s
unwillingness to make its citizens liable for foreign banks, the EU and
Eurozone chose to leave its banks unaided while toxic or non-performing
loans continued to fester. The EU’s article 32 provides that equity and
bondholders suffer financial loss before national governments are
permitted to deploy taxpayer funds. It is a policy first developed by
the EU, in conjunction with the IMF and ECB, in the rescue of Cypriot
banks in 2015 when even certain large depositors’ funds were seized to
make the banks whole. It was termed a ‘bail-in’.
MdP is a relatively small bank. As of June 30, 2016, its assets came in at just $182.9 billion, ranking the bank at only 121st largest internationally (www.relbanks.com).
Regardless, the news of its potential collapse sent shock waves through
Italy’s banking community. However, the crisis does not appear to be
contained (as they never are). Italy’s second largest bank, UniCredit,
S.p.A, with a deposit base of almost $1 trillion, has also come under
intense scrutiny. But the larger bank was able to gain shareholder
approval for a 10:1 reverse share split and a rights issue that raised
some $13.8 billion of new capital. The combination met the demands of
Article 32 of the EU Directive for a bail-in. It may have restored
confidence sufficiently to ensure survival, for a time at least, without
government intervention.
The case of Monte dei Paschi was very different. The bank had waited until December 21st to
declare that it had sufficient liquidity to last only four months. The
shareholders of Monte dei Paschi, by the close of 2016 had
experienced a large fall in earnings per share (EPS) and an almost
complete collapse in the share price for the year.
To make matters worse, like mortgage-backed securities that were
distributed by Wall Street in the early 2000’s, junior bonds in Italian
banks were sold to risk averse retail investors as ‘sound banking
investments’. The degree to which rank and file investors are exposed to
the bank has made the case a politically charged issue.
On December 21, 2016, Italy’s finance minister, Piercarlo Padoan,
implored his Parliament for rescue funds. Posturing that the Italian
banking system was “solid and healthy”, he nevertheless urged adoption
of government restructuring plans so that banks could “… travel on
their own legs, be profitable, and finance the economy.” Later that day,
the Italian Parliament approved a bank bail-out package of
$20.8 billion. However, Goldman Sachs had estimated earlier that almost
$40 billion would be needed to ensure long term survival. (Financial
Times, R. Sanderson, J. Politi, M. Arnold, 12/21/16) A London analyst
had forecast even more.
The range and conflicting data surrounding the bank’s rescue make
it unlikely the real amount necessary to halt the escalating Italian
banking crisis is known or can be known any time soon. In today’s highly
interconnected financial world, Italy’s banking problems are not
restricted to Italy or even to the European Union. Estimates are that
French, German, Japanese, Spanish, UK and U.S. banks are exposed to the
debts of Italian banks approaching half a trillion dollars.
Important general elections are due this year in France, The
Netherlands, Germany and, owing to the failed Italian referendum, in
Italy. In addition, Brexit has set a precedent in the minds of the
European public that it is possible to escape the clutches of the EU.
Also, should the UK succeed in leaving, the EU will lose its second
largest economy and financial contributor. Doubtless, this potential
erosion of EU funding and the recently exposed possibility of democratic
‘revolution’ will act to focus the minds of the EU’s bureaucracy
increasingly on finding a political solution to Italy’s banking woes.
In aggregate, the problem facing certain European banks is so
enormous that even bail-ins could prove politically untenable. A
temporary stopgap could be an interim nationalization of Italian and
perhaps other European banks. It might dawn gradually on politicians,
bankers and even investors as a means of averting a financial and
monetary meltdown and thereby help to secure unity within the EU.
Furthermore, nationalization would save the banks and their depositors
while, at the same time, allowing for much needed banking reforms and a
return to more prudent lending practices. The recent rise in Italian
bank share prices may indicate this view is gaining credence.
In conjunction with the current ‘war on cash’ and the growing
pressure to initiate a global taxation system, bank nationalizations
undoubtedly would mean a significant government intrusion into citizens’
cash and therefore over citizens’ lives, a major forward step in the
globalist agenda.
John Browne is a Senior Economic Consultant to Euro Pacific Capital.
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