Tuesday, July 12, 2016

Italy on the Brink

By Joseph T. Salerno
As several articles over the past few days have indicated (herehere,here and here), Italy is on the brink of a full-blown banking crisis. Bad debts, or "non-performing loans," held by the banking sector total  360 billion euros, which is a remarkable 17 percent of all the outstanding bank loans in Italy and equal to about one-fifth of the annual Italian GDP. It is also many times the level of bad debt held by Italian banks at the peak of the financial crisis in 2008. Since the beginning of 2016, prices of bank stocks have decreased by more than 50%. In the case of Italy's oldest and most troubled bank, Banca Monte dei Paschi di Siena, its share price has declined more than 75%. It doesn't help that the Italian economy is struggling mightily to recover from the last financial crisis and is still 8% smaller than it was in 2008 and roughly the same size as it was at the end of the twentieth century.
The Italian government is considering bailing out the banks in defiance of EU rules concerning "bail-ins." These rules require that a bank's creditors, especially bondholders, "take haircuts" before taxpayer funds can be used to "recapitalize" the banks. The Italian government is reluctant to follow these rules because almost half of the banks' junior, or subordinated, bonds, about 31 billion euros worth, have been sold on the retail market to households and individuals rather than to professional investors. In the case of insolvency, the holders of junior bonds are the last of the bank's creditors to be paid.  In its appeal to the EU to suspend its bail-in rules, the Italian government is portraying the retail purchasers of these bonds as small and naive savers. But this does not ring true.  In 2015 the Italian government rescued four small banks. In compliance with EU rules it put the burden of the rescue on bank creditors rather than taxpayers. As a result, 12,500  "small savers" lost a total of 430 million euros on junior bonds. That is an average of 34,500 euros lost per bondholder.  
Let us consider these "small savers" whom the Italian government is so eager to protect.  In 2013, net wealth of the median Italian household was 145,469 euros, including real and financial assets. It is hard to believe that a household which was savvy and disciplined enough to accumulate this amount of net wealth would be so  naive as to rashly invest almost one quarter of it in risky junior bank bonds, especially considering that total bank bonds constituted around 3% of gross household wealth in 2013. The reasonable inference is that subordinated bank bonds are a small part of the diversified portfolios of those households whose net wealth is far in excess of the median, that is, rich and likely politically connected households. This would explain why the Italian government is so hell bent on using taxpayer funds from the get-go to bail out the banks.  
Negotiations between the Italian government and the EU on this issue may soon be rendered pointless, however, if "various unconfirmed rumors of Italian cashless ATMs end up being true." 
The above originally appeared at Mises.org.


  1. If a crisis happens quickly they might still be able to blame it on brexit...

  2. Anything is possible with a printing press.