How a banking crisis in Italy could reverberate around the world

The value of Italy’s third-largest bank has plummeted by 60 percent since the start of this year. There are signs many are pulling money out of Banca Monte dei Paschi, out of Italian banks, and out of Italy in general. Even if the nation is not hit by a banking crisis imminently, the dire situation in Italy’s banks and its whole economy could still cause a financial disaster in Europe that would reverberate around the world.

We’re not talking a Greece-type crisis here. Italy is the eurozone’s third-largest economy, and the eighth largest in the world. Its economy is over seven times the size of Greece’s. An economic collapse in Italy would put Europe in a crisis far, far worse than the ongoing Greece crisis.

The more immediate roots of the problem go back to the 2008 banking crisis. Italy’s economy was hit hard, especially the poorer south. To this day, southern Italy is still struggling. The unemployment rate there is 22 percent—only slightly below Greece’s. On the island of Sicily, the youth unemployment rate is over 75 percent—far worse than in Greece.

Because of this economic devastation, many could not pay their debts. This is a problem across the eurozone, but it is worse in Italy than in any other large European economy. Around 20 percent of loans are not being paid back. These non-performing loans are worth over €200 billion (us$218 billion).

Europe’s muddling in the face of this economic crisis is making things worse. Elsewhere, governments bailed out struggling banks only to find themselves overwhelmed with debt and in need of a bailout. But rather than address the underlying cause of the crisis—that sharing a currency without sharing a government can never work—European leaders focused on the effect: They simply made it illegal for governments to bail out struggling banks without taking money from some depositors and investors first.

These laws went into force on January 1. They’ve solved nothing and instead are pushing the crisis in a different direction.

(Listen to our Trumpet Hour discussion of this subject at 19:00.)

We saw a glimpse of this in December. The Italian government organized a rescue for four small banks along the lines of the new bailout rules. It ended in one elderly man committing suicide after losing his life’s savings. He had tried on several earlier occasions to withdraw his money, but was refused. Many others have lost out and are angry. The banks are accused of making investments sound like a normal savings account without explaining the risks involved.

This situation will become more common with the new banking rules. Shareholders, bondholders and anyone with over €100,000 ($109,000) in deposits must take losses before the government can bail out the bank. That may sound like a lot of money, but someone’s entire life savings or pension fund could easily come to €100,000. Even a small business could also have that much in a bank—let alone large ones.

Those were the conditions forced on Cyprus back in 2013. It devastated Cyprus’s economy and not only led to people losing their savings, but also to drastic pay cuts as businesses struggled to find the cash to pay their staff. Leaders of the European Union promised it was an exceptional case. Now it is the rule.

There are no good ways to bail out a bank. The old way involved handing taxpayers’ money to wealthy investors, which feels rather unseemly. But the alternative—taking money from the bank accounts of pensioners—isn’t great either. Throw in the fact that in the eurozone, the robbed pensioners live in one country and the abused taxpayers in another, and it’s easy to see how any discussion on how to bail out banks can quickly turn into a heated argument.

The new way of doing things makes the entire banking system more unstable. As Geopolitical Futures wrote, “Banking is about to get risky and complicated in Europe.” If investors and depositors risk losing large sums of money if their bank goes under, they’ll be much quicker to ditch a questionable bank, which makes a bad situation much worse very quickly.

“The smartest investors should be heading for the exits as soon as they sense trouble,” wrote the Financial Times. Under this new bailout system, “action by a handful of anxious investors could conceivably precipitate a crisis that did not need to happen,” it states.

That process seems underway with Banca Monte dei Paschi. Reuters quotes a Milan bond trader who warned that “[e]veryone is trying to get out.” A fund manager warned, “Over the past few days many have been wondering about the pace at which people closed their accounts and sold bank bonds.”

“I wouldn’t call it a bank run but there are definitely outflows,” he said.

Since then, things have calmed a little as the Italian government agreed to a new plan with the EU that will allow the government to provide some limited help to struggling banks. But this merely shifts the burden for some of the problems—it does not solve them. Details are still being worked out, but if the aid is small, it will not help, and if it is large, it will shift the problem to the government—which can’t afford to deal with it.

Italy’s debt relative to the size of its economy is second only to Greece—and it is still borrowing money every year. Meanwhile its economy has been shrinking over the last few years. It cannot afford to bail out its banks. Its deposits-guarantee fund—which exists to ensure that those with under €100,000 don’t lose anything in a bankruptcy—is almost certainly inadequate.

An Italian banking crisis could easily push the whole country into very serious trouble. A truly massive European bailout would be required to fix it.

Even if the crisis calms down again, the non-performing loans remain a major problem. A financial crisis triggered elsewhere could easily push Italy over the edge. It’s a box of gelignite in a room full of explosives—ready to add its “boom” after the first bomb goes off.

But even now, the banking problems are fueling the political divide in Europe. The new bailout rules are Germany’s design—they force countries to raid money from their own business and savers before they come asking for money from German taxpayers. Predictably, Germany is quite happy with this situation, while Italy is not.

“Italy will not stop demanding to have its voice heard,” wrote Italian Prime Minister Matteo Renzi in the Guardian last week. He wrote that the “political and cultural orthodoxy that has monopolized thinking on how Europe should be run [a diplomatic way of saying ‘Germany’s way of doing things’] isn’t working.”

Renzi wants a European scheme to back up troubled banks—which would prevent any meltdown being so calamitous to Italy, and may even prevent a crisis in the first place.

“The eurozone economic crisis has evolved into a political crisis where a growing number of voters oppose the European Union and the political elites who back it,” wrote Stratfor.

Italy’s banking problem threatens to dramatically worsen the euro crisis at the same time as Europe struggles to deal with the migrant crisis. It is becoming more and more clear that the European Union in its current form is not working.

“Europe will be forged in crises, and will be the sum of the solutions adopted for those crises,” wrote one of the EU’s founding fathers, Jean Monnet. Whether it comes to migrants and borders, or banks and the economy, the status quo is failing. Europe must either fall apart and go back to being separate nation states or act more like one superstate with a common border, common border force, common spending policies and common solution for struggling banks.

An economic crisis coinciding with the migrant crisis would tax Europe to the extreme. But it will take this kind of extreme pressure to force the quarrelsome nation states to give up sovereignty and unite together, exactly as men like Monnet saw. The euro crisis will, in fact, bring Europe together—and the next major push in that direction could come from Italy.

For more on where this crisis is leading, read Trumpet editor in chief Gerald Flurry’s article “Did the Holy Roman Empire Plan the Greek Crisis?”