Ian Pye wrote this
article. Ian is an independent economic and geopolitical researcher as well as
a strategic planning and business development advisor. His articles and
analyses on international affairs, economic trends and cultural topics have
been published in various mainstream and alternative press sources. Mr. Ian’s
wider intellectual interests are reflected in his writings on the convergence
of foreign affairs, political philosophy, history, global finance and energy
policy. He has undergraduate degrees in economics and political science from
the University of California and a Master’s degree in finance from Cambridge
University.
Ian Pye is an
independent economic and geopolitical researcher as well as a strategic
planning and business development advisor. His articles and analyses on
international affairs, economic trends and cultural topics have been published
in various mainstream and alternative press sources. Ian’s wider intellectual
interests are reflected in his writings on the convergence of foreign affairs, political
philosophy, history, global finance and energy policy. He has undergraduate
degrees in economics and political science from the University of California
and a Master’s degree in finance from Cambridge University.
The 2007 – 2009 Financial Crisis
was not a one-off historical event, and it was most certainly global in
scope. Yet the means deployed to quell and contain it by the world’s
central and private banks, as well as their corresponding governments and other
regulatory bodies, ultimately served to kick fiscal and monetary cans down the
road. Various central bank balance sheets ballooned to unprecedented debt
levels, foremost being the
books of the US Federal Reserve, which saw its balance sheet climb from $869 billion
to over $4.5 trillion in a decade of both treating, and
preventing a reprise of, said crisis.
Yet, the problems that led to the first crisis are still latent – and
threaten at clearly larger scales – within the world economy. So, when and how would the ‘second leg’, as
it were, of this extended global deflationary cycle commence? What
event(s) would trigger it, and could said event(s) be prudently forecast, let
alone prevented?
European
Banking Contagion
Four European banks have failed over the past eight months alone,
giving strong indications that another 2007 corrective brink may be at hand. These institutions were Banco Popular of
Spain, and three Italian banks - Monte dei
Paschi di Siena(MPS), Veneto Banca
and Banca Popolare di Vicenza. Popular was taken over by rival Spanish
Banco Santander with help from the EU, MPS was taken
over by the Italian government in a state recapitalization,
and the latter two banks were also assumed by Rome in order to split their
“good” versus “bad” assets and liabilities between
Intesa Sanpaolo, Italy’s largest bank, and the Italian state,
respectively.
Notedly, no state aid
was provided to Banco Popular in its sale to Santander.
Popular apparently had financial
books in better shape than did MPS upon its takeover. Per
analyst Don Quijones ,
“[i]n fact, if anything, Popular had a better problem loan ratio on its balance
sheet than MPS. While the Spanish entity was ‘resolved’ through the
cancellation and redemption of its convertible and subordinated shares and
bonds, MPS was recapitalized with government money.”
Private versus public economic
priorities evidently become lucid through such desperate cleanup exercises,
among other items.
Intesa bought the “good bank” assets of both
latter failed banks while the “bad bank” assets, including non-performing loans
(NPLs), subordinated bonds and non-functional legal arrangements were bought by
the Italian state, which will pass the costs onto taxpayers, as per the advice
of Rothschild Bank, advisor
to the Italian Treasury. Italian citizens will bear the €5bn - €6bn arrived
at immediate cost of these twin bailouts, on top of their lost savings. Senior bondholders received
protection by Rome whereas junior
creditors and the banks’ shareholders lost their shirts via
this “rescue”.
In what has come to be fairly predictable
denial behavior, merely weeks before the Veneto and Vicenza seizures, and per
finance analyst and writer Wolf Richter,
“Italy’s Minister of
Economy Pier Carlo Padoan insisted that
the two banks would not be wound down. Last year, to dispel the mountain of
evidence to the contrary, he insisted that that there would be no need of any
future bail outs; and that, furthermore, Italy did not even have a banking problem.”
Said denials officially precede what they deny could or will happen, yet which
then often do, and this latest theater is thus seemingly no different from denials floated
prior to the worst of 2008’s
failures.
Public Outrage,
Private Blessings
The use of taxpayer money
for the Veneto and Vicenza bailouts went against provisions established by the
European Commission and European Central Bank (ECB), ultimately
revealing the frantic stakes reached in conducting such emergency measures,
despite lack of admissions from banking and government officials. These
bailouts sidestepped a 2016 EU law involving the need for the specially
designated Single Resolution Board to
coordinate matters.
Yet said board, taking the lead from the ECB, “decided that
resolution of the banks under the new EU rules was ‘not
warranted in the public interest’”. There were political reasons for
handling the twin banks’ bailouts with such haste but also presumably reasons
involving the need for averting systemic fiscal risks spiking. The former
reasons tend to be emphasized in the mainstream corporate press; the latter,
not so much.
Despite established EU protocols for handling distressed banks
and public objections raised by EU bureaucrats over these twin Italian
bailouts, signals here point toward tacit blessings having been given by the EU and ECB
because “Italy was able to argue there was regional economic
risk from the failure of two important regional lenders.” Confidence
would’ve suffered dramatically, and the two lenders
had failed to raise private capital as prescribed since the
beginning of 2017. By contrast,
Santander raised some €7bn to fund Popular’s takeover.
Warning in early June of
the potential for a systemic crisis, the Italian Economy
Undersecretary Pierpaolo Baretta stated that, the “collapse of two regional
banks in Italy's Veneto region [would’ve triggered] a systemic crisis [that’d
have] risked dragging down the whole domestic economy.” Brussels got
out of the way of timber falling, and especially by avoiding their prescribed
“bail-in”[i]procedures, which would’ve caused outright
public panic in said instances. Per US based geopolitical analyst George Friedman, the
bail-in is a formula for bank runs. Rome wants to make sure depositors
don’t lose their deposits. A run on the banks would guarantee a meltdown …The
bail-in rule exists because Berlin doesn't want to bail out banking systems
using German money.
Additionally, and as per Analyst Don Quinones,
the Italian government decided to commit €17 billion in taxpayer funds to
bail out senior bondholders and depositors. This includes a €5 billion capital
injection for Intesa, which is getting the good assets and liabilities, such as
deposits. The €5 billion is to protect Intesa against losses from those assets.
Prohibited “state aid” under EU rules? No problem. It has now been
cleared by the EU Commission. [emphasis added]
This is all a mere hint of what’s expected to come further, both
in Italy as well as other plagued EU economies. Why? For one,
monstrously unprecedented levels of public and private
continental debt.
How ‘Systemic’ Could It Get?
The twin Venetian bank failures are consistently portrayed as
small and thus relatively insignificant events. This is judged based on
the collective €60bn
price tag of bailing them out - certainly not a loss
figure to sneeze at - yet that nonetheless is indeed modest by comparison to Italy’s wider economy, which
retains a nearly $2tn
GDP. Still, said summary ignores the systemic basis
of risks which sit latent in many institutions due to their derivatives and off
balance sheet exposures. Per Economist Francisco
Pereira, though “there were disagreements over the prospect
of contagion given the small size of the banks, the Italian government, the
Commission and some within the ECB clearly felt the risk that it might impact
other bank bonds, or even Italian sovereign debt, was still too big and
dangerous to ignore.”
As of Fall 2016, the stock index of Italian banks and that of Deutsche Bank (DB) of Germany, which
retains over $46+ trillion of
gross derivatives risk exposure as well as questions
regarding its solvency health, had been “moving in tandem”
despite DB and said Italian banks carrying different surface challenges.
I.E. DB doesn’t have the Italians’ NPL problems. And yet,
why the correlated graphical movements? Perhaps because DB is also so exposed to Italy that an
Italian banking crisis would eventually pose contagion to a multiple size of
what happened in 2008?
Per Friedman
again, since “Italy
is the fourth largest economy in Europe, [hers] is the mother of all systemic
threats … [T]he IMF recently
said Deutsche Bank is
the single largest contributor to systemic risk in the world. A rippling
default through Europe will hit Deutsche Bank”, let alone trigger an EU-wide
banking crisis which would most certainly spread immediately across the
Atlantic.
Relatedly last Fall, the Bank of
Italy categorized the nation’s top three banks UniCredit, Intesa Sanpaolo and
Monte dei Paschi as “systemically important institutions”. Hence the
bailout of MPS, and per Reuters,
the categorization of UniCredit as “Italy’s only globally systemically
important institution (G-SIFI)”, alongside all three Italian banks also being
labelled as “Other Systemically Important Institutions” (O-SII).
What – or better yet, who – could or even would
tip the perceptual balance into “crisis mode”? During negotiations for bailing out MPS, not only did
JPMorgan walk away, but so did two prominent New York hedge funds – Fortress
and Elliott - despite being offered an 80% mark down on MPS’ NPLs, which was clearly
not enough to attract and keep such private investors.
The government then stepped in. Can it continue to under such
continuing perceptual duress and growing lack of confidence?
Wider
Banking Consolidation Agenda
As with the 2007 – 2009 Crisis,
there is an inevitable, widespread, transatlantic shrinkage expected in the
number of banks out there, and not only by acute fiscal necessity, but
seemingly by longer term design as well. In such a game, the largest
global banks routinely stand to assign, rearrange or outright ‘hoover up’ the
assets of ‘expendable’ banks deemed to be culled. In Europe, the “Club
Med” or Mediterranean nations’ banks are seemingly more expendable and ripe for
consolidation versus, say, German or French mega-banks like BNP Paribas,
Société Générale and Deutsche Bank.
Per Analyst Pascal
Straeten, the capital of the top EU banks averages 4.5% of total assets (versus
6.6% with the top US banks) […] Two of France’s biggest banking institutions,
namely BNP Paribas and Société Générale, have capital of only 4% of total
assets as of end 2016 while Deutsche Bank sits at the bottom of the barrel with
3.5% …
Additionally,
as always, the northern EU countries are imposing their will onto their
southern brothers with middleman the ECB and the EU Commission acting as
middlemen. Look at how much austerity is being imposed on the citizens of Greece, Spain, Portugal and Italy; look at the
restructuring measures being imposed on the Spanish and Italian banks, but not
too much onto the French or German banks. To illustrate this point, look at the
Spanish bank Banco Popular, until recently Spain’s sixth largest banking
institution, is no longer alive. Its assets, including a massive portfolio of
small-business clients, now belong to Banco Santander, Spain’s biggest bank. The fact that neither German nor French banks have suffered a similar
fate is a clear demonstration of the double standard ingrained in the EU’s
finance industry.
Per an oddly frank admission
within the otherwise City/Wall Street establishment-abiding FT of London,
“Bank
consolidation is definitely the hidden agenda at the EU level — they want to
move to a US-style model centred around a few larger players,” says a hedge
fund manager specialising in bank debt. “The only issue is that this cannot be
done without victims: big banks don’t want to buy small banks when they are going
concerns,” he adds. [sic]
Who assigns and executes such
‘wash and rinse cycles’, how frequently, and why, ultimately? Is the European Commission itself
co-tasked with such bank consolidation duties? “Clearly this [I.E.
Deciding the fate of European lenders] is putting way too much power on
the European Commission — the European Commission is not supposed to be a
resolution authority; it is only supposed to deal with competition,” per this
cited head of research at a European investment firm.
Relatedly, JPMorgan was
recruited to help save the twin Italian banks but ultimately
walked away, and presumably not just for fiscal reasons; said bank is the most
powerful in the US, and one of the top five in the world. Hence it will
tend to influence wider global banking practices, trends and strategies.
The desire for wider EU banking consolidation is palpable as the inevitability
of another global financial meltdown nears. JPMorgan
recently ordered US domestic consolidation among mid-sized
banks, per the Federal Reserve’s imminent (I.E. As early as December 2017)
balance sheet shrinkage, which it deems as eventually presenting funding
problems for said tiers of banks. This event begged structural and
systemic questions over JPMorgan’s relationship with the Fed itself.
How much have the 2008 and
imminent global financial crises served, or will serve, for wider, sweeping
macro-strategic imperatives and expected ‘debt jubilees’ among the West’s
largest banks? For global financial ‘governing bodies’ such as the IMF
and Bank for International Settlements? What extensive, longer term
international money order is being sought through part and parcel ‘creative destruction’
involving such periodic transcontinental asset consolidations via seemingly
nonlinear chaos?
Italian
Economy Generally Weak, as is the Wider EU Economy
Said three Italian banks were
merely reflective of wider, more disturbing trends in the country’s
economy. Italy’s general NPL ratio is
close to 14% of its overall banking industry’s loan book, and close to 12% of
Italy’s GDP itself as of the end
of 2016. Italy
belongs to the EU country group with the
highest level of non-performing loans, with an NPL coverage ratio of 49% (as of December 2016), above the 45% EU
average. Within
such an environment of financial duress, almost any bank failure could send
shockwaves through the system, pushing other banks closer to the tipping point.
Italy’s general banking
foundation is so fragile, and a viable market for accommodating deteriorated
credit so lacking, that it has not been able, per Don
Quinones again, “to offload their estimated €360 billion of
non-performing loans, many of them with very weak, if any remaining, collateral
underpinning them. Yet on average, they are marked at around 50 cents on the
euro.”
Per Reuters last
Fall, “Italian banks are widely seen as under capitalised and they
are struggling under a pile of bad loans left behind by a deep recession that
ended in 2013.” [sic]
Macro economically speaking, Italy’s debt to GDP ratio is in
excess of a shocking
130%, its national youth unemployment is north of 37%,
with overall official unemployment at 11.3% (well over twice official US
unemployment) and the
labor force participation rate is only at 65%.
Deeper public and institutional confidence has been negatively affected because
of this reckless finance gamesmanship over the years, only to be followed by
such wanton bailing out of banks inevitably buckling under said gamesmanship.
Per Analyst Iakov
Frizis, according “to research on Italian bank balance sheets
conducted by Mediobanca Research, out of 500 Italian banks, 114 are at
risk, exposed to an excessive amount of credit that surmounts the net value of
their tangible assets.” These 114 have Texas ratios[ii] north
of 100%, “meaning that
they don’t have enough capital to cover all the bad stuff on
their books.”
Additionally,
Intesa Sanpaolo and UniCredit, Italy’s largest banks, have weak general
solvency data registered and are clearly reliant upon the broader collective
stability of Italy’s overall banking industry. UniCredit is the largest
lender yet cannot help in such bailouts because it already has raised
€13bn this year for salvaging itself as a going concern.
Genoa-based Banca Carige, Italy’s ninth largest, founded in 1483 and carrying over €26bn in assets, is another
problem case, having been
told by the ECB to fix its asset quality issues lest it too be
culled. Carige has
lost over €2bn over the past four years, and although
technically in better shape than the previously closed three banks, still faces
a third cash call since 2014. It will also face troubles in ridding its
books of bad loans, especially as the Italian and wider EU economies sour
further. Will Carige require the same controversial treatment by the
state which Veneto and Vicenza just received?
It’s a waiting game, due in part
to perception management by governments and banks which directly influence
them. There’s a tactical delaying factor at work as far as debt handling
goes, alongside generally desperate hoping for a rapid turnaround in the Italian
economy’s performance. Possibly overly ambitious – even reaching –
national economic growth forecast figures have been issued by the IMF and
internal organizations. One rosy
depiction states that “Confindustria, the Italian employer
federation, last week increased its 2018 growth forecast to 1.1 percent from
1.0 percent. But even those forecasts might have been jeopardized had the
distressed Venetian banks been left to fester.” Yes, but how did their
bailing out necessarily lead to boosted collective consumer – let alone
institutional – confidence? Especially as, again, more “zombie banks”
litter the Italian financial landscape, waiting to roam at night?
The same
source cited above then goes on to provide negative caveats
regarding Italy’s weaknesses:
The [GDP]
growth numbers are still too low to fully dispel the risk that Italy’s NPL
problem will prove an economic drag. And Rome cannot
rescue bigger banks the same way; only robust growth of, say, 2 percent to 2.5 percent per
year can hope to make a real dent in the NPL problem given the fact that many
of the NPL are in obsolete industries like clothing and textiles for which
growth is largely irrelevant. Private capital inflow into the banks is
still required to finance the write down of these loans which often are carried
on the banks’ books at inflated prices.
Note the flippant criticism of
“clothing and textiles” (why not lambast the added banalities of the Italian
food, olive oil, wine and tourism industries while they’re at it?) as obsolete
for “growth”. Because Italy must essentially and effectively mimic German
machine manufacturing, exporting, aggressive technology and Anglo-American
finance innovation, to truly become a viable “player” alongside other “growth”
economies, correct? Because Italy clearly cannot continue to remain, in
essence, *Italian*? We’re sure there are drastic emergency pedagogical
measures available – via distance learning or otherwise – for getting millions
of leisurely Italians to learn how to code within six months…
Per Frizis again,
Italy faces a three-pronged national banking problem: A seemingly
unresolvable bad loan issue, a housing crisis due to correcting property prices
which further threaten collateral sanctities for bank lending, and a
dysfunctional, “politicized governance of lending institutions” which holds
back collective financial sector performance.
Meaning: Bail out all the tepid financial institutions you want, Rome and
/ or the ECB/EC/EU – you still will not structurally resolve
the matters at hand.
What would otherwise push these banks over the cliff? A systemic
event triggered foremost by a derivatives meltdown,
either within Italy or certainly elsewhere, due to the opaquely defined
counterparty relationships between institutions which have traded them, and the
wider nature of how derivatives risks go from “net”
to “gross” fairly quickly – thus defying prescribed definitions
– thereby spreading contagion across borders.
Too Much
Global Debt – and thus Risk – As Is
Systemic risk could easily spread
from a financially, pandemically plagued Europe to the US, considering that,
despite announced governmental figures painting economic indicators as
generally healthy, the
state of the US economy is much more precarious than advertised.
Per veteran
bond king Bill Gross, market risk is at its highest since the
pre-2008 Crisis era due to central bank policies for low-and negative-interest
rates “artificially driving up asset prices while creating little growth
in the real economy and punishing individual savers, banks and insurance
companies.”
Very similar sober sentiments are
shared by other senior investors, including Paul Singer of the Elliott hedge fund, who very
recently admonished investors and the public that
“distorted”
monetary and regulatory policies have increased risks for investors almost a
decade after the financial crisis.
“I am very concerned about where we are,”
Singer said … “What we have today is a global financial system that’s just
about as leveraged -- and in many cases more leveraged -- than before 2008, and
I don’t think the financial system is more sound.”
The US consumer debt picture
isn’t pretty. Per
Bloomberg,
In the first quarter [2017], 17 percent
of U.S. consumers said they were likely to default on a loan payment over the
next year, up from 12 percent in the third quarter, before the election …
The percentage of debt that’s at least
90 days delinquent rose to 3.37 percent in the first quarter, the second
consecutive quarterly gain, according to data from the New York Fed. It’s the
first time those delinquency figures have risen twice in a row since the end of
2009 and beginning of 2010. About 46 percent of Americans surveyed by
the Federal Reserve could not pay a hypothetical $400 emergency expense, or
would have to borrow to do so, according to a 2016 report …
Mortgage
debt has been growing slowly since 2012. The fastest-growing types of
borrowings have been student loans, credit cards and auto debt. For much of
this debt, there is either no collateral, like credit card loans, or collateral
whose value declines over time, such as cars …
Further, there is little to no wage growth in the US economy, which
hampers not just consumption trends but savings and investment. On top of this, consumers are more reliant
on credit to make their way. Per Bloomberg again,
Americans
faced with lackluster income growth have been financing more of their spending
with debt instead. There are early signs that loan burdens are growing
unsustainably large for borrowers with lower incomes. Household borrowings
have surged to a record $12.73 trillion, and the percentage of debt that is overdue
has risen for two consecutive quarters. And with economic optimism having
lifted borrowing rates since the election and the Federal Reserve expected to
hike further, it’s getting more expensive for borrowers to refinance.
Italy’s banking fiasco can thus
easily infect not simply its neighboring EU economies, but thereby rapidly
spread across the Atlantic, tipping over North American financial institutions
into crisis as well. The dynamics, esoteric or exoteric, involved in such
a worst-case scenario must be scrutinized as they are matters of both national
and world security. For the serious observer, the tools required for
said scrutiny by necessity will extend well beyond surface-level
academic and even corporate prescribed tools.
Source: Ibid.
[i] A “Bail-In” involves “rescuing a financial institution on the brink of
failure by making its creditors and depositors take a loss on their
holdings. A bail-in is the opposite of a bail-out, which involves
the rescue of a financial institution by external parties, typically
governments using taxpayers’ money. Typically, bail-outs have been far
more common than bail-ins, but in recent years after massive bail-outs some
governments now require the investors and depositors in the bank to take a loss
before taxpayers. Source: http://www.investopedia.com/terms/b/bailin.asp
[ii] “The Texas ratio takes the amount of a
bank's non-performing
assets and loans, as well as loans delinquent for
more than 90 days, and divides this number by the firm's tangible capital
equity plus its loan loss reserve.
A ratio of more than 100 (or 1:1) is considered a warning sign.” Texas Ratio http://www.investopedia.com/terms/t/texas-ratio.asp#ixzz4mmC7OgNP
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