What hits bottom first, Italy’s banking system or Germany’s Deutsche Bank? And if the Germans won’t allow the Italians to bail out their banks, will they hold to the same standard with Deutsche Bank? From Edward Harrison at pro.creditwritedowns.com:
As the Brexit worries began two weeks ago, I flagged Italian banks – more than the UK economy – as one of my principle concerns, because of the potential to cause systemic damage to the euro system. And now the contagion is spreading, with Deutsche Bank the most obvious weak link. The question now is twofold. First, does the Italian banking crisis solve itself without a major overhaul of EU institutional arrangements? Second, if not, how does the EU solve this problem? Some brief thoughts below.
About a year ago, as the Greek crisis was hot and heavy, I wrote a post on why the euro is a failure. And in that post, I used the Italian economy and Italian banks as the most obvious economic example. The reasoning here was that Greece was only a more extreme example of what could befall other weak European economies in a generalized economic downturn. The Troika had submitted Greece to the rack under the pretense that it was a separate case. My argument was that it was not a separate case, just a more extreme case – and potentially the first case of economic collapse due to the failure of the eurozone’s institutional setup.
My view then – and today – is that Italy matters to the eurozone and the EU almost as much as France and Germany, given its role as a founding member of the European Coal and Steel Community in 1951 and the European Economic Community in 1957. If Italy were forced into a desperate situation, it could be fatal for the euro. And now, a year later, this nightmare scenario is coming to pass – or at least we are getting a glimpse of it. We don’t know if this is a real crisis or a mini-crisis yet.
What we do know is that the Italian banks are both under attack from investors and simultaneously undercapitalized. We know this because Italian bank shares have fallen by more than half this year. And we also know that the Italian Prime Minister Matteo Renzi has floated the idea of injecting 40 billion euros of state-sponsored capital into the Italian banks. Meanwhile, the ECB has made liquidity available to the Italian banks – if they need it – under the proviso that solvent institutions may just be going through a liquidity crisis. But, as we saw in the US, with TARP, eventually more state capital was needed.
Now, let’s remember the constraints here. During the sovereign debt crisis, banks and sovereign credits became co-mingled because banks owned lots of sovereign debt. And so as sovereign debt soured, so too did the condition of euro banks. This eventually required a bailout of Spanish banks via the state, making clear that – given the lack of a common bank resolution mechanism – the contingent liabilities of banking systems fell to the state. The other major eurozone bubble economy, Ireland, suffered a similar fate after the sovereign was forced to bail out its banking system, mandating a Troika bailout for the state in turn. This is a situation that no one wanted repeated. In fact, if bail-ins – like the one in Cyprus that Willem Buiter warned us would become the model – were in effect, Ireland never would have needed a bailout. As people like myself suggested at the time, banks would simply have defaulted.
To continue reading: The problem at euro banks
Here’s an easy solution which the EuroPTB will never think of: Let them fail.