Market Update: Watch Out for the Boomerang Effect from the Latest European Referendum Shocker
The verdict is out from yesterday’s crucial Italian referendum. Prime Minister Matteo Renzi and his much-lauded political and constitutional reforms were officially repulsed. Now Italian President Sergio Mattarella must decide if he will call for new elections well ahead of the planned 2018 polls. If he does, the latest anti-establishment populist candidate Beppe Grillo and his 5 Star Movement will win the election and begin another more potentially damaging referendum on Euro membership that could have far reaching consequences for your investments.
Five Star Movement is the establishment’s worst nightmare. It is a dangerous marriage between EU-skeptic ideas and progressive pro-nationalist slogans like “bring back our Italian Lira.” They have already upended Italian local politics by winning the Mayor office in Turin and Rome in June. Their aim is to hold a second referendum on Italy remaining in the Eurozone if they win the election. Polls have them beating Prime Minister Renzi’s center-right Democratic Party if elections were held today, 53% to 47%.
The repercussions of the tsunami this referendum has unleashed are just building. The euro initially plunged to its lowest level against the U.S. dollar once Renzi announced he would make good on his threat to resign. Italy’s sovereign bonds have also slipped on the fears that the nationalist movements will gain momentum from the referendum. The yields on Italy’s important ten year notes have risen to over 2 percent following the outcome.
Italy’s top eight largest banks are already in deep trouble, even before the political uncertainty erupted with this latest European political earthquake. Third largest Italian lender Monte Dei Paschi was in the late stages of its most recent effort to revive its troubled financial fortunes with a 5 billion euros capital raising effort all the while it is trying to spin 28 billion euros worth of bad debts off its books. Investors may walk away from the effort now, forcing Italy to wade into the quagmire.
Other troubled lenders like Banca Carige of Genoa are also under intense pressure to rebuild their failing balance sheets, courtesy of the European Central Bank and its stress tests. These Italian banks are similarly buckling beneath the immense weight of over 360 billion euros worth of loans gone bad.
This ought to be enough to concern you and your investments. Italian banks are not the absolute largest in Europe or globally, though Italy’s biggest bank UniCredito is among the too-big-to-fail globally systemic important financial institutions whose future is in play now. Other continental banks are teetering from their own problems, including largest German lender Deutsche Bank which itself may require a German or ECB central bank bailout shortly.
Italy has so far managed to avoid endangering its own national balance sheet directly amid the crumbling ruin of its failing banking sector. If Monte Paschi is unable to complete this bad debt dump and balance sheet cash infusion program soon, the country will be forced to bail it out. This would hurt more than simply the pensioners whose own life-long savings are tied up in the oldest bank in the world.
New European rules require both bondholders and shareholders take a total loss as part of any state-backed aid. The 7th largest economy in the world is itself at stake. If Italy catches a serious virus, it will surely infect the other major G7 economies in short order, separately from the very real danger of international banking giant contagion possibilities.
How Well Will Your Portfolio Weather the Impending Banking Crisis?
Regardless of what happens with Italian and European lenders in general, American banks are also hiding their deteriorating financial conditions using complex accounting tricks. Both they and their backstop the FDIC are woefully undercapitalized against another banking crisis that begins in Italy or anywhere for that matter. Fortunately there is an insurance policy for failing banks in Europe and the United States.
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