This is how desperate the Italian Banking Crisis has become. When things get serious in the EU, laws get bent and loopholes get exploited. That is what is happening right now in Italy, where the banking crisis has reached tipping point. The ECB, together with the Italian government, have just this weekend to resolve Banca Popolare di Vicenza and Veneto Banca, two zombie banks that the ECB, on Friday night, ordered to be liquidated. Unlike Monte dei Pachi di Siena, they will not be bailed out primarily with public funds. Senior bondholders and depositors will be protected while shareholders and subordinate bondholders will lose their shirts. However, as the German daily Welt points out, subordinate bondholders at Monte dei Pachi di Siena had billions of euros at stake, much of it owned by its own retail customers who’d been sold these bonds instead of savings products such as CDs. So for political reasons, they were bailed out. Junior bonds play a smaller role at the two Veneto-based banks. According to the Welt, the two banks combined have 1.33 billion (at face value) in junior bonds outstanding. They last traded between 1 cent and 3 cents on the euro. So worthless. Only about 100 million were sold to their own customers, not enough to cause a political ruckus in Italy. So they will be crushed.
This post was published at Wolf Street by Don Quijones ‘ Jun 25, 2017.
Toxic loans as a result of corruption, political kickbacks, fraud, and abuse. The Bank of Italy’s Target 2 liabilities towards other Eurozone central banks – one of the most important indicators of banking stress – has risen by 129 billion in the last 12 months through November to 358.6 billion. That’s well above the 289 billion peak reached in August 2012 at the height of Europe’s sovereign debt crisis. Foreign and local investors are dumping Italian government bonds and withdrawing their funding to Italian banks. The bank at the heart of Italy’s financial crisis, Monte dei Paschi di Siena (MPS), has bled 6 billion of ‘commercial direct deposits’ between September 30 and December 13, 2 billion of which since December 4, the date of Italy’s constitutional referendum. Italy’s new Prime Minister Paolo Gentiloni, who took over from Matteo Renzi after his defeat in the referendum, said his government – a virtual carbon copy of the last one – is prepared to do whatever it takes to stop MPS from collapsing and thereby engulfing other European banks. His options would include directly supporting Italy’s ailing banks, in contravention of the EU’s bail-in rules passed into law at the beginning of this year. Though now, that push comes to shove, the EU seems happy to look the other way. While attention is focused on the rescue of MPS, news regarding another Italian bank, Banca Erturia, has quietly slipped by the wayside.
This post was published at Wolf Street on Dec 18, 2016.
China has failed to curb excesses in its credit system and faces mounting risks of a full-blown banking crisis, according to early warning indicators released by the world’s top financial watchdog. A key gauge of credit vulnerability is now three times over the danger threshold and has continued to deteriorate, despite pledges by Chinese premier Li Keqiang to wean the economy off debt-driven growth before it is too late. The Bank for International Settlements warned in its quarterly report that China’s ‘credit to GDP gap’ has reached 30.1, the highest to date and in a different league altogether from any other major country tracked by the institution. It is also significantly higher than the scores in East Asia’s speculative boom on 1997 or in the US subprime bubble before the Lehman crisis. Studies of earlier banking crises around the world over the last sixty years suggest that any score above ten requires careful monitoring. The credit to GDP gap measures deviations from normal patterns within any one country and therefore strips out cultural differences. It is based on work the US economist Hyman Minsky and has proved to be the best single gauge of banking risk, although the final denouement can often take longer than assumed. Indicators for what would happen to debt service costs if interest rates rose 250 basis points are also well over the safety line.
The odds are stacked against Matteo Renzi’s economic ambitions for Italy. The prime minister needs to see a blistering pace in the second half of this year to meet his goal of a 1.2 percent expansion in 2016. Economists say that’s not happening, spelling trouble for Renzi and the wider euro area. With Renzi facing a referendum in the autumn that could decide his political future, a stagnant economy and banks hobbled by bad debt are adding to his challenges. While cheaper oil, a weaker euro and unprecedented European Central Bank stimulus helped the Italian economy emerge last year from its longest recession since World War II, that can only take the recovery so far. ‘Italy’s potential growth rate is, as of today, still zero if not slightly negative,’ said Raffaella Tenconi, a London-based economist at Wood & Co. ‘Companies are still too indebted, profitability in the aggregate is very low and the economy overall is in a particularly challenging position having no fiscal or monetary-policy independence.’ Renzi’s government so far is standing by the 2016 growth projection it made in April, despite an economy that stalled in the three months through June. A constitutional reform referendum expected in November is rapidly turning into a test of the 41-year-old premier’s popularity, with unemployment that unexpectedly rose to 11.6 percent in June and a banking crisis that rattled investors large and small. Renzi has said he would quit if he loses the vote.
Last week everyone was clamoring about Italy. In the aftermath of the UK’s European Union referendum, markets started worrying about what a British exit from the EU, or Brexit, would mean for one of the euro area’s sore spots: Italian banks. But this week attention has started to shift over to Portugal – and not just because of its victory over France in the Euro 2016 final. Rather, markets are once again feeling antsy about the Iberian nation’s banking problems as macroeconomic conditions start to deteriorate. ‘The UK referendum hit an already vulnerable banking system in the eurozone. Italian banksare on the front burner, but the temperature is rising in Portugal,’ Marc Chandler, the global head of currency strategy at Brown Brothers Harriman, wrote in a Monday note to clients. ‘The country is struggling with a systemic banking crisis, the lack of a convincing medium-term fiscal plan and excessive public and private sector leverage,’ a Barclays team led by Antonio Garcia Pascual observed in a note to clients.
Italy is running out of economic time. Seven years into an ageing global expansion, the country is still stuck in debt-deflation and still grappling with a banking crisis that it cannot combat within the paralyzing constraints of monetary union. ‘We have lost nine percentage points of GDP since the peak of the crisis, and a quarter of our industrial production,’ says Ignazio Visco, the rueful governor of the Banca d’Italia. Each year Rome hopefully pencils in a fall in the ratio of public debt to GDP, and each year the ratio rises. The reason is always the same. Deflationary conditions prevent nominal GDP rising fast enough to outgrow the debt. The putative savings from drastic fiscal austerity – cuts in public investment – were overwhelmed by the crushing arithmetic of the ‘denominator effect’. Debt was 121pc in 2011, 123pc in 2012, 129pc in 2013. It came close to levelling out last year at 132.7pc, helped by the tailwinds of a cheap euro, cheap oil, and Mario Draghi’s fairy dust of quantitative easing. This triple stimulus is already fading before the country escapes the stagnation trap. The International Monetary Fund expects growth of just 1pc this year. The global window is closing in any case. US wage growth will probably force the Federal Reserve to raise interest rates and wild speculation will certainly force China to rein in its latest credit boom. Italy will enter the next downturn – perhaps early next year – with every macro-economic indicator in worse shape than in 2008, and half the country already near political revolt.
Italy is rushing to cobble together an industry-led rescue to address mounting concerns over the solidity of a banking sector whose woes pose a risk to the wider eurozone economy. Finance minister Pier Carlo Padoan has called a meeting in Rome on Monday with executives from Italy’s largest financial institutions to agree final details of a ‘last resort’ bailout plan. Yet on the eve of that gathering, concerns remain as to whether the plan will be sufficient to ringfence the weakest of Italy’s large banks, Monte dei Paschi di Siena, from contagion, according to people involved in the talks. Italian bank shares have lost almost half their value so far this year amid investor worries over a 360bn pile of non-performing loans – equivalent to about a fifth of GDP. Lenders’ profitability has been hit by a crippling three-year recession. The plan being worked on, which could be officially announced as soon as Monday evening, recalls the Sareb bad bank created in 2012 by the Spanish government to deal with financial crisis in its smaller cajas banks, say people involved.
More than a decade of profit gains at China’s largest banks probably came to an end last year, and the pain may deepen in 2016 as a surge in bad loans threatens their ability to maintain dividends. Combined net income at Industrial & Commercial Bank of China Ltd. and its four closest rivals probably slipped 0.3 percent last year, according to analysts surveyed by Bloomberg ahead of earnings reports due next week. The group boosted profits by an average 25 percent between 2004 and 2014. The weakest economic growth in a quarter century has driven soured credit at Chinese banks to a decade high, prompting the government to consider measures to resolve bad loans such as the debt-to-equity swaps that were used to clean up balance sheets following a banking crisis in 1999. The prospect of further bad-loan provisions drove big banks’ valuations to the lowest on record last month as investors speculated dividends might get cut. ‘Most investors are obviously bearish and should banks beat expectations on the bottom line, I don’t think that’s going to change their minds,’ said Matthew Smith, a Shanghai-based analyst at Macquarie Group Ltd. ‘There are deeper issues there – asset-quality related. The trend has been incrementally weaker.’
The three biggest banks are losing capital. A crisis of staggering proportions is looming in China, and tiny Singapore will be caught right in the middle of the storm once the disaster finally erupts. Speaking at the annual Barron’s roundtable, Swiss billionaire investor Felix Zulauf warned that Singapore’s largest banks are at risk of massive capital outflows if the Chinese economy experiences a hard landing, which he expects will happen this year. ‘We are in a down cycle that will end with crisis and calamity. China in today’s cycle is what US housing was during the financial crisis in 2008,’ Zulauf warned. Zulauf warned that capital outflows in China will continue, prompting regulators to devalue the yuan by as much as 15% to 20% within the year. When this happens, Asian economies which are heavily dependent on China – particularly Singapore – will suffer because Chinese corporates will cut their imports even more, while indebted Chinese companies will be placed at greater risk of default.
Italy’s banking crisis has long been brewing, and the markets appear to be taking it seriously for the first time since European Central Bank President Mario Draghi defused the last market panic by promising to do ‘whatever it takes to save the euro’ in mid-2012. Either way, the market sell-off could seriously damage Italy’s economy. New regulations brought in at the start of the year heighten the risk of a bank run because investors and depositors must now bear the pain of an Italian bank going bust. This is a strong incentive for a bank’s depositors and investors to move their funds elsewhere if they believe the bank is in danger (sentiment plays a role again), and there are reports that Monte dei Paschi depositors are doing just that. Italy and the European institutions must now look for ways to reverse the sentiment that is making Italian banks the victims and reassure the markets of the banks’ safety.
Financial crises take about a decade to be born. Having lived through four of them, I see the raw materials for a fifth one – flowing from the collapse of so-called leveraged loans – debt piled on top of companies with weak credit ratings. Before examining the latest news on leveraged loans, let’s take a quick tour down the memory lane of financial crises I’ve lived through. My first one was in 1982 – that’s when banks lent too much money to oil and gas developers in Oklahoma and Texas as well as local real estate developers. At the suggestion of McKinsey, money-center banks like Chemical Bank thought it would be a great idea to buy a piece of those loans. It’s all described nicely in a wonderful book – Belly Up. Too bad the price of oil and gas tumbled, leaving lenders in the lurch and causing a spike in bank failures that gave me the chance to spend a balmy summer in Washington helping the FDIC develop a system to manage the liquidationof those failed banks. By 1989, it was time for another banking crisis – this one was pinned to too much lending to commercial real estate developers in New England and junk-bond-backed loans for what used to be known as leveraged buyouts. The government shut down Bank of New England and was threatening my employer, Bank of Boston, with the same. I worked on a government-mandated strategic plan intended to save the bank from a similar fate.
The 1st of October came and went without financial armageddon. Veteran forecaster Martin Armstrong, who accurately predicted the 1987 crash, used the same model to suggest that 1 October would be a major turning point for global markets. Some investors even put bets on it. But the passing of the predicted global crash is only good news to a point. Many indicators in global finance are pointing downwards – and some even think the crash has begun. Let’s assemble the evidence. First, the unsustainable debt. Since 2007, the pile of debt in the world has grown by $57tn (37tn). That’s a compound annual growth rate of 5.3%, significantly beating GDP. Debts have doubled in the so-called emerging markets, while rising by just over a third in the developed world. John Maynard Keynes once wrote that money is a ‘link to the future’ – meaning that what we do with money is a signal of what we think is going to happen in the future. What we’ve done with credit since the global crisis of 2008 is expand it faster than the economy – which can only be done rationally if we think the future is going to be much richer than the present. This summer, the Bank for International Settlements (BIS) pointed out that certain major economies were seeing a sharp rise in debt-to-GDP ratios, which were well outside historic norms. In China, the rest of Asia and Brazil, private-sector borrowing has risen so quickly that BIS’s dashboard of risk is flashing red. In two thirds of all cases, red warnings such as this are followed by a major banking crisis within three years. The underlying cause of this debt glut is the $12tn of free or cheap money created by central banks since 2009, combined with near-zero interest rates. When the real price of money is close to zero, people borrow and worry about the consequences later.
When the banking crisis crippled global markets seven years ago, central bankers stepped in as lenders of last resort. Profligate private-sector loans were moved on to the public-sector balance sheet and vast money-printing gave the global economy room to heal. Time is now rapidly running out. From China to Brazil, the central banks have lost control and at the same time the global economy is grinding to a halt. It is only a matter of time beforeSTOCK MARKETS collapse under the weight of their lofty expectations and record valuations. The FTSE 100 has now erased its gains for the year, but there are signs things could get a whole lot worse.
Imagine that the euro had never been introduced and we instead had had freely floating European currencies and each country would have been free to choose their own monetary policy and fiscal policy. Some countries would have been doing well; others would have been doing bad, but do you seriously think that we would had a crisis as deep as what we have seen over the past seven years in Europe? Do you think Greek GDP would have dropped 30%? Do you think Finland would have seen a bigger accumulated drop in GDP than during the Great Depression and during the banking crisis of 1990s? Do you think that European taxpayers would have had to pour billions of euros into bailing out Southern European and Eastern European governments? And German and French banks! Do you think that Europe would have been as disunited as we are seeing it now? Do you think we would have seen the kind of hostilities among European nations as we are seeing now? Do you think we would have seen the rise of political parties like Golden Dawn and Syriza in Greece or Podemos in Spain? Do you think anti-immigrant sentiment and protectionist ideas would have been rising across Europe to the extent it has? Do you think that the European banking sector would have been quasi paralyzed for seven years? And most importantly do you think we would have had 23 million unemployed Europeans?
We have shown so far that all ruble crises were accompanied by a strong U. S. dollar and low oil prices. We have concluded that Russia’s current problems resemble those from 1998, though possibly even more severe than seventeen years ago, because the biggest country in the world is cut off from the international funding. But what about the following banking crisis in Russia? Let’s begin by explaining why the next full-blow financial crisis is coming, even though Russian public debt is very small (less than 10% of GDP). We have to remember thatwhat really counts is future fiscal balance. It involves the role of expectations of the future stance of public finance and explains why governments in crises often have surprisingly large foreign currency reserves and run small or no deficits at all. The best example was the Asian countries in 1997. According to Eichenbaum et al., the Asian crises was caused by ‘large prospective deficits associated with implicit bailout guarantees to failing banks’. The same mechanism operated in Russia. Investors simply noticed that the oil and gas industry generates about half of Russia’s revenues, so the government, unable or unwilling to raise taxes or cut spending, will run deficits in the future. These expectations were enhanced by the implicit bailout guarantees of Putin’s cronies. This is why Russian bond yields and credit defaults swaps with measuring bankruptcy risk for Russia and have already hiked (Russia’s government 10-year local bond yield jumped from 10% in November, 2014 to 14% in January, 2015, while CDS spiked in January, 2015 by 100 basis points to 630).
This post was published at GoldSeek on 16 February 2015.