The Italian Financial Crisis Begging for Money

July 28, 2016

            One can agree after the US financial crisis that there has always been a social contract between banks and the state itself. However, what happens if the social contract such as the case in Italy deteriorates and negatively begins to affect the public? If the Italian government has decided to capitalize the banks then the obvious question is why have their non-performing loans bulged to the point where the public itself must subsidize? 


           If the contractual relationships on a personal scale often break down due to commitment problems then there’s no doubt that the social contracts between Italian banks and the government will also deteriorate. The problem with Italy is that their banks are willing to expand their balance sheets without realizing that Italian banks and bondholders are unwilling to hold onto these risks. 


            The bondholders are making it very clear that the government risks their reputation of being undermined if bailouts aren’t initiated. The Italian financial community is willing to argue that the bailout is worth paying to avoid financial instability.


            Italian Prime Minister Matteo Renzi may believe that liquidity ratios have fallen and that the Italian banking balance sheet trend indicates a pronounced rise in banking systemic risk. This inevitably affects returns by bank shareholders and means that the Italian banks’ high leverage will affect equity returns by making balance sheets more fragile. Sure the Italian government can render all possible assistance and allow banks to expand their balance sheet, but the problem here is that they underestimated their liquidity support and their underperforming collateral now requires a haircut.


            The Italians are not like the Greeks. For one thing, they do not want to lose face internationally. Even when they beg for money, for them it’s not begging at all. For the Italians it becomes a requirement that the European Union has to lend them support regardless of circumstances.


            Since Germany and Italy are likeminded, there’s no problem in recapitalizing the Italian banking system. However PM Renzi has a different alternative. He wants the common Italian to pick up the tab. If the increasing higher leveraged assets held by Italian banks are 90% of total assets, then that means banks can not increase their balance sheet simply because of the fact that rising assets are materialized with lower prices rather than higher prices. This is why their tangible assets are considered to be underperforming with little scope of generating liquidity.


             What's comical is that housing prices are 30% below their peak in 2008 before the financial crisis hit. Many CEO's of Italy's financial institutions are reiterating the same thing of what Spain has indicated, "The ECB's negative interest rate policy is killing European banks", stated the President of BBVA, the second biggest financial institution in Spain. A 30% decline will not stabilize within a year, it will only worsen as people and companies fall behind on mortgage payments digging a larger debt hole for the banks that lent them the money. Europe is a mess, but you only have to thank Draghi, this man knows how to appease himself along with Janet Yellen. 


            The problem with Italy is the level of corruption, embezzlement, and fraud that underpins the economy to a shadowy world of tax evasion. Even with the influx of immigrants, the underworld is able to capitalize on the government’s generosity. This isn’t only Italy’s generosity, but Germany’s and all the Scandinavian countries willing to pay tribute to Italy’s growing immigration. It’s ideal for Germany to accept this because it means Germany has nothing to do with it. 


            It’s odd that the European Union insists that it’s the bondholders that must bear the costs of recapitalization. We need to face the truth: if there were back-door deals with Portugal then why can’t there be back-door deals with Italy, especially with immigration scandals. So Italy doesn’t want their reforms to be given up after 5 years of progress. What progress are they exactly talking about? What did Renzi do in terms of reform in education and the financial industry?


            If the reforms were real and tangible then why are they seeking a 45 billion Euro bailout? Why is Renzi blaming the bondholders who undertook the risk? Now many accountants will argue that the bondholders deserve to get wiped out, but Renzi is saying something different. He wants Italians to pick up the risks of the bondholders. The question is why?


            One may come to terms with the Italian norm that there should be two banking systems in Italy: one representing the North and the other the South. We all know that the Northern Italians despise the Southern Italians as ignorant peasants and argue that the South shouldn’t even be part of Italy. But then again we all must come to terms that Southern Italy’s philosophy may have crept into the government’s psyche. Renzi asking Northern Italians to foot the bailout simply isn’t a plausible solution.


            It’s just too bad that this young man who had such high hopes and aspirations for the Italian economy is plummeting in the polls. The US banking system did the unthinkable; they sought higher equity returns and increased their asset pool. The US loves to boost shareholders’ payoffs. The only difference with Italy is that we all know where this money is going to go with these payoffs.  


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