Best of the Week
Most Popular
1.The Brexit War! EU Fearing Collapse Set to Stoke Scottish Independence Proxy War - Nadeem_Walayat
2.London Terror Attack Red Herring, Real Issue is Age of Reason vs Religion - Nadeem_Walayat
3.The BrExit War, Game Theory Strategy for What UK Should Do to Win - Nadeem_Walayat
4.Goldman Sachs Backing A Copper Boom In 2017 - OilPrice_Com
5.Trump to Fire 50 US Cruise Missiles To Erase Syrian Chemical Attack Air Base, China Next? - Nadeem_Walayat
6.US Stock Market Consolidation Time - Rambus_Chartology
7.Stock Market Investors Stupid is as Stupid Goes - James_Quinn
8.Gold in Fed Interest Rate Hike Cycles- Zeal_LLC
9.The BrExit War - Britain Intelligence Super Power Covert War With the EU - Nadeem_Walayat
10.Marc Faber: Euro to Strengthen, Dollar to Weaken, Gold and Emerging Markets to Outperform - MoneyMetals
Last 7 days
EURUSD at a Critical Point in Wave Structure - 23rd Apr 17
Stock Market Grand Super Cycle Overview While SPX Correction Continues - 23rd Apr 17
Robert Prechter Talks About Elliott Waves and His New Book - 23rd Apr 17
Le Pen, Melenchon French Election Stock, Bond and Euro Markets Crash - 22nd Apr 17
Why You Are Not An Investor - 22nd Apr 17
Gold Price Upleg Momentum Building - 22nd Apr 17
Why Now Gold and Silver Precious Metals? - 22nd Apr 17
4 Maps That Signal Central Asia Is at Risk of War - 22nd Apr 17
5 Key Steps For A Comfortable Retirement From Former Wall Street Trader - 22nd Apr 17
Can Marine Le Pen Win? French Presidential Election Forecast 2017 - 21st Apr 17
Why Stock Market Investors May Soon Be In For A Rude Awakening - 21st Apr 17
Median US Household’s Wealth Has Declined by 40% Since 2007 - 21st Apr 17
Silver, Platinum and Palladium as Investments – Research Shows Diversification Benefit - 21st Apr 17
U.S. Stock Market and Gold, Post Tomahawks and MOAB - 21st Apr 17
An In Depth Look at the Precious Metals Complex - 20th Apr 17
The Real Story of China’s Strong First-Quarter Growth - 20th Apr 17
3 Types Of Life-Changing Crisis That Make You Wish You Had Some Gold - 20th Apr 17
The Truth is a Dangerous Thing - 20th Apr 17
2 Choke Points That Threaten Oil Trade Between Persian Gulf And East Asia - 20th Apr 17
Gold’s Next Downside Target Is Around $700… Even if It Breaks Up First - 19th Apr 17
SPX May be Completing its Corrective Pattern - 19th Apr 17
Silver Production Has “Huge Decline” In 2nd Largest Producer Peru - 19th Apr 17
Soothing East Asia's Nerves as Trump's Administration Reaffirms US Power in Asia-Pacific - 19th Apr 17
The Brexit War - Article 50 Triggered, General Election 2017 Called - Let the Games Begin! - 19th Apr 17
Plungers Big Trade - The Oil Short - 18th Apr 17
The Smart Money Is Piling Into Regenerative Medicine - 18th Apr 17
If You Invest In Stocks Now, Expect No More Than 3% Returns In The Next 20 Years - 18th Apr 17
Maps That Explain Wars In The Middle East And North Africa - 18th Apr 17
Theresa May Calls Snap BrExit UK General Election Capitalising on Crippled Labour Party - 18th Apr 17
Is US Economy at the Cusp of the Next Recession? or Maybe Worse? - 18th Apr 17
US Housing Market Mortgage Delinquency Rates Increase & 3X ETFs - 17th Apr 17
Trump US North Korea First Strike Smoke and Mirrors, China is the Real War Target! - 17th Apr 17
Now Is The Time To Invest In Canada’s Marijuana Boom - 17th Apr 17
History of the Post WWII Crude Oil Price From a Technical Perspective - 17th Apr 17
Stock Market Bounce Coming? - 17th Apr 17

Market Oracle FREE Newsletter

50+ Global Markets. Today's Top Opportunities. (April 12-20)

Italy, Germany, and the EU Are on the Brink of a Conflict

Politics / European Union Jan 11, 2017 - 05:25 PM GMT

By: John_Mauldin

Politics

BY CHEYENNE LIGON AND ALLISON FEDIRKA : As a new year begins, we look at a key forecast that will bridge 2016 and 2017: the Italian banking crisis. In Geopolitical Futures’ 2016 forecast, we said that the focal point of Europe’s financial crisis would shift from Greece to the Italian banking system. For 2017, we forecast that the evolution of this crisis will eventually force a confrontation between Italy, Germany, and the European Union. Here, we establish a starting point for the looming Italian banking crisis in 2017, which will unfold over many months and have a range of consequences.


The key bank to watch

Italy’s banking crisis currently pivots around the fate of Banca Monte dei Paschi di Siena (MPS). The bank spent 2016 trying to shed 28 billion euros ($29.6 billion) in non-performing loans (NPLs), which account for 36 percent of the bank’s loan portfolio. That is the highest proportion of NPLs of any Italian bank.

As a result, investors and depositors began taking out their money. This added to the bank’s financial crisis by creating a liquidity problem. In December, MPS said that its remaining 11 billion euros in liquidity would only last until April.

The bank’s efforts to privately solve its financial woes failed, leaving the Italian government as the bank’s last recourse. MPS spent the fourth quarter of 2016 seeking 5 billion euros of capital and a fund to underwrite it. The bank failed to meet its December 22 deadline, after the deal’s largest backer pulled out at the last minute.

With the private sector and outside financial institutions reluctant to help, MPS asked the Italian government for aid. On December 23, the Italian Cabinet said that the bank would be rescued with a 20 billion euro fund approved by Parliament.

The next obvious question is will 20 billion euros be enough to save MPS? While the sum would meet MPS’ immediate needs, estimated at about 8.8 billion euros, many independent researchers believe it will not save the bank in the long run. Goldman Sachs estimates that successful recapitalization would require 38 billion euros. A senior market analyst at London Capital Group suggests the number might be closer to 52 billion euros.

The broader consequences

As a member of the eurozone, Italy’s banking crisis is not just an Italian problem. Uncertainty in the Italian market could lead risk-averse investors to stay away from Italian assets and thus the euro, impacting its value.

Also, should MPS or other large Italian financial institutions fail, Italy would sink into an economic crisis that would have severe effects on other EU members and the value of the euro.

Italy, in theory, also needs to comply with EU regulations. The divergence between Italy’s needs and the EU’s needs has made finding a solution acceptable to both parties very difficult. Italy wants to protect taxpayers while the EU wants depositors, not the European Central Bank (ECB), to assume the burden of debt.

The solution thus far has been to promote a plan in which Italy appears to be following EU regulations, but which provides enough wiggle room to protect the bank’s domestic investors. Article 32 of the EU’s Banking Recovery and Resolution Directive, which took effect at the beginning of 2016, states that banks must go through a “precautionary recapitalization,” also known as a bail-in, before they can get state funds. This is meant to protect taxpayers from bearing the entire burden of a bailout.

In MPS’ case, this would mean that bondholders must take an 8 percent loss in assets before the government can inject capital into the bank. However, the ECB is negotiating a plan with the Italian government in which the bank could protect these retail investors by swapping their riskier junior bonds for more stable senior ones.

Germany, as de facto leader of the EU, is the main force behind the ECB’s opposition to bailouts. Germany has elections in 2017 and is also facing a looming crisis due to falling export demand. Politically and economically, it cannot keep propping up the eurozone.

The EU must walk a fine line of being flexible enough to avoid financial collapse, but stringent enough to preserve the union’s institutional integrity—at least what remains of it. But Italy’s December 4 constitutional referendum gave the Italian government more leverage. Italian voters rejected former Prime Minister Matteo Renzi and his negotiator approach with the EU. This reflects the public’s growing desire for Italy to do what is best for Italy, even at the expense of the EU.

Domestic political implications

These economic problems naturally affect the lives of average Italians. Problems like inflation, stagnating growth, and unemployment affect their pocketbooks. A 4 billion euro bail-in for four smaller Italian banks in 2015 led to protests, after 130,000 bank shareholders and bondholders lost their investments. Renzi was fiercely criticized, and residual anger drove many voters into the arms of anti-establishment parties.

Paolo Gentiloni, Italy’s new prime minister, has asked the EU to let Italy protect retail investors to avoid a repeat of Renzi’s experience. An estimated 40,000 households in Italy hold 2 billion euros of MPS’ subordinated bonds. The loss of life savings for 40,000 families in Italy could spark unrest and lead to a flare-up in anti-EU sentiment.

All parties understand that if the EU does not allow the Italian government to protect its retail investors, nationalist parties like the Five Star Movement and the Northern League will become more popular. Both parties have promised a Brexit-style referendum if they come to power in Italy’s 2018 elections. It would also cause public pressure that the future prime minister, to be selected early this year, could not ignore.

This would not only jeopardize the frail political and economic landscape in Italy, but also the entire eurozone. While MPS is just one bank, the ripple effects of its failure would be numerous and deep. This would severely escalate the crises already underway. The bank’s salvation would allow Italy and the EU to fight another day, but it’s a far cry from solving the underlying structural causes of Italy’s problem.

Grab This Free Report to See What Lies Ahead in 2017

Now, for a limited time, you can download this free report from Mauldin Economics detailing the rocky roads that lie ahead for three globally important countries in 2017—and how the economic fallout from their coming crises could affect you. Top 3 Economic Surprises for 2017 is required reading for investors and concerned citizens alike. Get your free copy now.

John Mauldin Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife