SLL has always disliked the term “contagion” when it is applied to systematic financial failure. It implies some sort of disease that hops from one financial institution or government to another. The term was used frequently in the last financial crisis, but the reality is that financial institutions and governments are all heavily leveraged. The better analogy is a common disease that manifests itself at differing times, and once one or a few start showing symptoms, others inevitably follow. Stepping off the pedantic soapbox, here’s a good article, notwithstanding the “contagion” in the title, on the looming European banking crisis, from Don Quijones at wolfstreet.com:
French and German banks.
Contagion is the reason Italy’s banking crisis is all of a sudden Europe’s biggest existential threat. Greece’s intractable problems are out of sight, out of mind; Brexit momentarily spooked investors and bankers; but Italy’s banking woes have the potential to wipe out investors and undo over 60 years of supranational state-building in Europe.
The last few days have seen growing calls for taxpayer-funded state intervention, a practice that was supposed to have been consigned to the annals of history by Europe’s enactment of new bail-in rules on Jan 1, 2016. The idea behind the new legislation was simple: never again would taxpayers be left exclusively holding the tab for European banks’ insolvency issues while bondholders were getting bailed out. But even before the new rules have been tried out, they are about to be broken, or at least bent beyond all recognition.
A loophole has already been found in the rules that would allow the Italian government and European authorities to raid European taxpayers in order to prop-up Italy’s third largest publicly traded bank, Monte Dei Paschi, while leaving bank bondholders and creditors whole, as Reuters reported a few days ago:
The rules, which have been in force since January, allow a state to directly acquire a stake in a bank that fails a stress test and cannot raise capital in the markets because of “a serious disturbance” in the domestic economy.
Oh, and no bank is officially allowed to pass or fail the European Central Bank’s 2016 stress tests, as we reported a few months ago, after a number of banks, including nine Italian banks, failed the test in 2014. Clearly, those at the top of the financial pecking order — banks and their bondholders — are protected once again from the disastrous consequences of another market meltdown, one that in many ways they precipitated.
The fact that in Italy, thanks in part to a quirk of the tax code, some €200 billion of bank bonds are held by retail investors adds an extra political dimension to the mix, as The Economist points out:
If the bail-in rules are applied rigidly in Italy, the outcry from savers will both damage confidence and leave the door to power open for the Five Star Movement, a grouping that blames Italy’s economic troubles on the single currency.
But it is the direct contagion effect that has Europe’s policymakers and central bankers most concerned. Contagion is a particularly acute problem in the Eurozone due to the so-called “doom loop” that exists between sovereigns and their banks, thanks in large part to the ECB’s tireless efforts to underpin both Europe’s biggest banks (by providing them with an endless supply of free money) and its bond markets (by doing “whatever it takes” to make European sovereign bonds virtually risk-free).
To continue reading: Who’s Most Afraid of Contagion from Italy’s Bank Meltdown?
Just another symptom of Greshams Law at work.