Sunday 17January2016 - The Crumbling Financial Edge!

From Mauldin's weekly newsletter.

George Friedman comments on Italy's failing banks. Will an Italian bank holiday be the event that kicks off the next world financial crisis?

Friedman: Italian Debt Crumbles
Now let’s turn to geopolitical concerns for a moment. All my readers have had a chance to look at George Friedman’s 2016 forecast. New readers can access a summary for free here and find a link to the full version. I can’t tell you how thrilled I am that George has partnered with Mauldin Economics. He brings so much to our table with his insights. Rather than go over what you have hopefully already read (and if you haven’t, you should), let me highlight one position he has clarified further since he wrote that forecast.
In a note entitled “The Precarious State of Italian Banks,” George and his team gave us an update on the serious financial problems facing Italy. You can find good news, but the bad news overwhelms the good. Nonperforming loans have now reached $216 billion, which is about 17% of Italian GDP. We have already seen some Italian banks fail rather spectacularly, and we are going to see that number increase. There is never just one cockroach. And while depositors are covered up to €100,000, that doesn’t do much good for businesses and wealthier households.
Italian bank debt is now very suspect. As it happens, Italians, rather than depositing their money in the bank at very little or no interest, buy bank bonds to get at least some return. In the recent spate of bank closings, 130,000 shareholders lost €790 million. The four small banks that failed represented just 1% of total Italian bank deposits. The total amount of bank debt held by Italian households is €237.5 billion. That’s billion with a B. Think of it as high-yield debt on steroids – except that it is generally very low-yield.
It’s not clear whether the Italian insurance deposit scheme has the money to cover even a fraction of the bigger potential losses. The ratio of assets to deposits covered is about 250 to 1. Now, the US FDIC’s required ratio is about 100 to 1, but US banks don’t have nonperforming loans of 17.9%, either.
There’s a lot more to this story than my brief summary can detail, but the point is that the problems in Europe don’t stop with the immigration crisis. The credit crisis of a few years ago has not gone away. Italy’s debt-to-GDP is growing every year, and it was already at a critical level five years ago – before the ECB took rates into negative territory and bought massive quantities of Italian bonds. They can continue to do that, but can they buy Italian deposits and defaulted bank debt? That’s rather doubtful. This is a story we will be watching closely as it unfolds this year.