Will Italy Prompt a Global Financial Crisis?

The current situation is definitely not pretty. In the turmoil that affects equity markets, banks seem to be taking center stage. Among them, Italian banks have become the center of attention.

European banks are not in good health
The recent assessment of the International Monetary Fund that European Banks have not provided for 900 billion dollars of bad loans is not particularly reassuring. As early as this week, former Governor of the Banque de France Christian Noyer was bold enough to state that "Eurozone banks are going very well. It is solid". It is precisely that official speech that is the first source of worry. Is it denial or public relations? None of those are part of a Central Bank Governors' job description.
The reality should be sobering. In the last five days Deutsche Bank shares lost 15% of their value.
But nowhere has the situation been worse than in Italy where the bad loans amounted at the end of December 2015 to $234 billion. They represent on average 17% of the loan portfolios against 7% for the Eurozone.

Monte dei Paschi di Siena: the bad bad bank
On the verge of bankruptcy, the oldest European bank, Monte dei Paschi di Siena, was rescued by the Italian Government. The European Central Bank (managed by an Italian) even created a new category of support by governments to allow this to happen. The collapse was the consequence of frauds in derivatives and the purchase of another bank at an outrageously high price. Mismanagement and fraud under the eyes of the Banca d'Italia.

That would however not be a disaster since MPS is the third largest bank in Italy. Of course, the Italian Government is in denial. Yet the stock price fell in a few months from 2.5 euros to 0.50 euros. There are talks about a rescue by the other Italian banks...who themselves, with the exception of Istituto San Paolo di Torino, are in trouble.

Unicredit loses 45% of its value
The largest bank of Italy was caught by a series of bad news that its meager profit could not correct. It lost 46% of its value since the beginning of the year. Two years ago it had to be recapitalized at half the value of its existing shares. A collapse of Unicredit would be impossible. It is a systemic Italian bank and it would make Italy's situation even worse.

Italian sovereign bond yields jump
Anticipation of an intervention for the Italian banks led to an increase of the yield of Italian 10-year bonds from 1.41 to 1.68% in a little over one week. It is the result of the persistence of the Italian indebtedness, second only to Greece with a 132%ratio of debt to GDP. That in turn will reduce the value of the bonds of the Italian Tesoro held in the balance sheets of Italian banks. Even if the accounting rules do not force them to account for the change, the fact is that their bad loans turn into sovereign weakness that turns into further losses fo Italian banks. The perfect vicious circle. Since Italian soveriegn bonds represent more than 120% of the equity of banks, the decrease in value weakens the equity position of banks. With no growth, the mere effect of the interest rates is to increase the debt to GDP ratio.

The 2.5 trillion dollar question
See from the US it looks as the same as Greece. There is however, a major difference: Italy's public debt amounts to 2,470 billion dollars. The European Central Bank or the European institutions do not have the means to rescue Italy as they did for Greece that amounted to 350 billion. that means that it would be, at least a major banking and economic crisis in Europe. I do not believe it will limited to Europe. This Italian and European banking crisis will represent a multiple of the 2008 crisis.

Is there a pilot in the plane?