If You Thought Brexit Was Bad Wait Until The Italian Banks All Go Bust

If only the German language had a word for schadenfreude we could be using it to describe our feelings as we watch what the German insistence on the eurozone rules is doing to that very eurozone system. Yes, of course, people all over the place are shouting about how terrible it is that Britain is leaving the European Union and isn’t Brexit terrible and so on. Yet the manner in which those eurozone rules are driving the entire Italian banking system into bankruptcy is a very good reason why we have left and why we should have left. Who actually wants to be part of a system that will bankrupt an entire financial system in the name of the stability of the financial system? But that is what is happening here:

The German government is open to a state rescue of Italian banks that would partially protect retail investors but it remains firmly against shielding all creditors from losses, a senior government source told Reuters.
That points to a slight softening in tone over efforts to defuse an unfolding banking crisis in Italy, although Berlin still flatly rejects a push by Rome to protect all investors, big and small, from any fallout.

Two points should be made here. The first being that it is the very rules which Germany has insisted upon which have led to the Italian banking crisis. Secondly, that the uncertainty over what will be insisted upon which is making it worse. The basic problem is clear:

If you think Britain’s banks are in bad shape, spare a thought for the Italians, where the country’s battered lenders are rapidly crumbling under an astonishing €360bn (£300bn) of bad loans.

While most people fret about the fallout from Brexit, some experts believe Italy’s banking crisis represents a far greater threat to the eurozone.

The problem is that Italy’s financial system needs a substantial bailout, but EU “bail-in” laws prevent prime minister Matteo Renzi from undertaking one without first wiping out the banks’ shareholders and bondholders.

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There are people trying to navigate through this, certainly there are, but it’s not obvious that anyone can succeed:

The Italian government is working on plans to set up a €50bn bad bank which would aim to clean up the country’s stricken lenders, the Sunday Telegraph has learned.

It is understood that €10bn of public money could be used to buy bad loans at a knock-down price, taking assets with a face value of €50bn off the banks’ hands, allowing them to start giving out more good loans instead.

The scheme, which is being put together by JP Morgan, could help clean up the banks, but also puts the country’s authorities on a collision course with the EU, which does not want taxpayers bailing out banks before private investors take a hit.

So, the basic problem. The Italian banks are sitting on those vast bad loans. They’re not bad because they went on an ill advised lending spree or anything, they’re bad loans because the euro has meant that Italy has had basically no economic growth in a decade, possibly more (no, this is not, absolutely not, all about the Great Crash). Italy’s economy simply cannot cope with the fiscal and monetary policy strictures of euro membership. That’s why there’s been no growth. And a static economy will turn loans bad because of course there’s always an expectation that the economy will grow built into any lending model.

So far so bad. It would be premature to insist that all of the Italian banks are bankrupt but the system as a whole definitely needs help. However, now we come to the second part of the German imposed rules surrounding the euro. This is the “bail in” provisions. In order to foster financial system stability the Germans insisted that we must tackle moral hazard. This is the idea that banks will behave recklessly because they know that they will be bailed out if they threaten stability by going bust. So, the eurozone rules now say that a bank can only receive aid, only be bailed out so as to prevent that danger to financial stability, if the equity holders lose their money and the bond holders and larger depositors (ie, those not covered by the minimum deposit insurance) also lose some of their. This is bailing in creditors to save a collapsing bank.

But what happens then is that if a bank looks like it is getting into trouble then no one will buy shares to increase the equity base, no one will buy bonds and larger depositors will flee. Essentially these rules mean that a potential bank run becomes an actual one. Which is, in the eyes of some analysts at least, what is currently happening to the Italian banks. Of course, if they do go down then that will have a much greater effect on the European economy than whatever trivia Brexit causes.

Which brings us back to the deficiencies of the German language. It is German insistence upon the monetary and fiscal rules surrounding euro membership which has caused no Italian economic growth. The lack of that growth has soured all too many of the Italian banks’ loans and left them on the solvency precipice. The German insistence upon rules to foster financial stability by banishing moral hazard have led those same Italian banks unable to raise capital and left them facing an induced liquidity problem. How lovely it would be if German really did have a word for schadenfreude.

Source: Forbes.com

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