So, Renzi lost his referendum on Sunday, he resigned as Prime Minister and his government is in limbo. The often-delayed private capital refinancing of Italy’s most troubled large bank, Monti di Paschi, has apparently gone into limbo as well. Surely the European banking system was crushed yesterday in the stock market and the euro was pummelled while the dollar soared? None of the above, dear reader. But be patient.
Why did markets do the reverse of the obvious? It’s all about previous positioning. Renzi was expected to lose the referendum so, unlike the Brexit and Trump votes, the market leaned the right way on this one. The dominant trade was to go long the dollar and short the euro and European banks. As the market opened, ‘someone’ gunned the euro and the banks. The shorts were forced to cover in a hurry and we were off to see the wizard. The net result: no panic in the stuff people were worried about. So I guess there really is no Italian banking problem after all?
Wrong. There is a huge Italian banking problem. Non-performing loans (NPLs) held by the banks total at least 17% of assets or about €680 billion. For the U.S. banks in 2008-9, the NPLs never got to 5%. An estimated €360 billion of these NPLs are impaired but write-downs have been less than half of what is needed and €85 billion in NPLs have not been written down at all. Total Italian banking system capital is generously thought to be €225 billion. This is insolvency dear reader, and private capital has rejected getting into this mess for years now. Because the Italian economy has been contracting for the past 10 years, the problem only gets worse.
Now it becomes a political problem. Germany wants Italian bank shareholders, debt holders and large depositors to pay for the needed recapitalization under the new E.U. resolution law. Italy wants anything but.
One good day in the market changes nothing. Something has to be done. Today, the credit-rating agency Fitch added some more fuel to the Italian bank fire, announcing it has changed its outlook on Italian banks to negative, a reflection of “its increased vulnerability to shocks following the asset-quality deterioration (which) has increased urgency and risks for Italian banks”. The European banking system as a whole is bleeding confidence and cash as depositors send their money out of Italy, Spain and Portugal, and, more recently, out of Germany too. We are moving towards an insolvency and liquidity crisis. The European banking system passed its best before date in 2007. Now it is starting to smell.