Italy is facing its greatest crisis in the postwar era. The country’s banking system is bankrupt, and no one in Europe is willing to fix it. As a result the euro could start to drift toward dollar parity as the situation in Europe goes from bad to worse.
The comments above and below are excerpts from an article by Boris Schlossberg (moneyandmarketswhich has been edited ([ ]) and abridged (…) to provide a faster and easier read.
To give you an idea of just how bad things are, you need to understand that banking regulators generally begin to worry when banks’ nonperforming loans reach 5% of assets. In Spain, during the height of their insane housing bubble bust in 2010 — when the whole country appeared bankrupt — nonperforming loans never went much above 10%. In Italy today, however, the number of nonperforming loans is not 10%, not 12%, not even 15% — it’s a whopping 18% of assets…
The solution to any banking crisis is straightforward: You bankrupt the stockholders and the bondholders and then you recapitalize the banks. According to most estimates, Italy would need about $40 billion to get the job done — a large but doable number. However, there is one very nasty glitch to the whole plan. In Italy, the bonds of the banks are not owned by institutions, but by many mom and pop retail investors. According to Bank of America Merrill Lynch, households own 14.6% of bank bonds… and the banks do not want to frighten them so we find ourselves in a standoff. German Chancellor Angela Merkel and even the Italian-born head of the European Central Bank, Mario Draghi, refuse to budge on this issue and will not bail out the Italian retail bondholders.
Italy’s technocratic Prime Minister Matteo Renzi is desperately trying to reason with them, but so far the talks are at a standstill. If Italy is forced to do a “bail-in” — which is bankers term for bankrupting the bondholders — the political backlash could break Europe apart.
Italy already faces a very strong independence movement in the Five Star party that has been winning local elections at an alarming rate. If Merkel and Draghi force Matteo to effectively wipe out 15% of the country’s wealth as a result of recapitalization, the backlash will make Brexit look like child’s play. Italy is not Greece. It is the third-largest economy in the eurozone and, if it goes, the eurozone will crumble soon thereafter.
Little wonder then that the euro has not been able to get off the mat all week long. Investors are clearly worried about the “Italian problem” and have already taken the unit below the psychologically important 1.1000 level against the dollar.
If the all the parties concerned can’t come to a practical agreement soon, euro could start to drift toward dollar parity as the situation in Europe goes from bad to worse.