George Freidman’s new daily letter Reality Check (December 11) is quoted below. (See: https://geopoliticalfutures.com/assessments/.)
“The Italian banking system is in serious trouble, and the failure of these four banks is simply the tip of the iceberg. An Italian pensioner committed suicide this week. He hung himself after the Italian government’s rescue of small four banks wiped out his life savings. The bailout was carried out under the principles which governed Cyprus’ bailout. All of the stakeholders in the bank, including depositors, were at risk in the banks’ failure. These were small banks, so the reality of what was happening did not strike home immediately. This man’s suicide did. Italian consumer protection groups, Adusbef and Codacons, have demanded a criminal investigation into the case. This suicide and subsequent reaction by consumer defense groups mark the first glimmer of growing public concern over the security of bank deposits in Italy. As tensions grow between Italy and the EU over the country’s banking system, as well as the Italian government and domestic public pressure, conditions will come closer to realizing Geopolitical Future’s 2016 forecast of a banking crisis in Italy.
The Italian banking system is in serious trouble, and the failure of these four banks is simply the tip of the iceberg. Non-performing loans, loans that debtors are not paying off as agreed, but which have not yet been written off by the banks, have been rising. At this point 18 percent of all outstanding loans in Italy are non-performing. That is an extraordinarily high level, particularly when you consider that Italy is the eighth largest economy in the world and the fourth in Europe.”
We asked our long time friend and skilled financial journalist, Vincenzo Sciaretta for some local views after sending him George Friedman’s missive. Vince has covered Italian financial markets and economics for decades.
Some bullets follow and then our conclusion. We thank Vince for his prompt responses.
1. Newspapers report that yesterday Banca Popolare di Vicenza (a small local bank) told its employees not to sell its subordinated debt any longer to retail investors, apparently because there’s no market. This also happened in another small bank, Veneto Banca.
2. It seems to me the article below does not specify that the bonds in question were subordinated debentures, while the ordinary bondholder was not touched. (It seems the bailing of the four banks affected some 130,000 stock holders and some 15,000 holders of subordinated debentures; it seems there are around about 60 billion of subordinated debt issued by the banking sector, not just these four small banks. I can safely say that many of the buyers of these subordinated debts were unaware of the risks accompanying these instruments. And that, since the debts were not listed in official markets, their value was quite opaque, and they were not easy to sell once you bought them.
3. Of the four banks, the stocks of Etruria were listed; the other three were not. However, some subordinated debentures of the non-listed banks were exchanged, and some people bought them in the secondary market at, say, 30 cents to the euro; so the risk was, in those cases, not hidden from view.
4. The article says the nonperforming debt is some 18%. I have data indicating that it is higher. Some estimates are 22%–23%: Out of 1,532 billion in loans, 200 billion is “real” bad debt now. I don’t know the exact English terms here, but the bank has already started actions against the debtor, while 127 billion is the amount of the debt where the client is late in the payments but still not yet indicated as insolvent. And another 17 billion is in transition between the two categories above.
5. In the stock market, banks and insurance companies are a large share. In fact, if you invest in Italy’s stock market, you essentially are investing in financials and a large oil company and some utilities.
6. It’s not true that savings have been going down in Italy. However, the main point is that the new European rules really ask that the depositor (and the bond holder) check the health of the bank, and this process is very, very risky. I have a wonderful book named The Panic of 1907, by Bruner and Carr, about US banks at the time. If I remember well, there was a cascade-like collapse of many banks, even relatively sound banks, because people ran on the banks, and this went on and on until Mr. Morgan entered the scene.
7. Let’s be frank: few know the real health of a bank, certainly not the average citizen, so there is a risk that people will initiate a run on the banks even on rumors. Yesterday there was a television show on the collapse of the four banks, and one representative of an association of consumers mentioned that there are other banks in even worse shape, in his opinion, mentioning another local bank named Banca Popolare di Vicenza. That was just his opinion, a “rumor,” you might say. And another participant in the show said, Ok let’s see now in the next few days and weeks what will be the reaction of the clients and stakeholders of Banca Popolare di Vicenza in response to this declaration of yours. So I do think the new rules are ill-conceived. Rumors may lead actions; panic may lead action; doubt can lead action. Whether this happens or not remains to be seen, but the fragility exists.
Thank you, Vincenzo, for this extensive response. Usually you are interviewing me, and now we get to reverse roles to provide meaningful insights to our readers.
Clients of Cumberland know that we do not own Italy in the international ETF accounts. And we do not own debt instruments tied to Italy.
Clients also know that we do not own high-yield funds or high-yield securities in the US. We avoid credit risk when that risk is opaque.
We speculate that a contagion risk connection looms between the issues in European and eurozone banking and the high-yield sector in the US. Did any of the opaque hedge funds or mutual funds use currency-hedged devices to establish high-yield positions in Europe? Doing so would have been an easy way to chase yield. What was disclosed to investors by those funds? A million questions arise now as the ongoing saga of Third Avenue and the subsequent fund lockouts unfolds. For Cumberland, we are glad to have avoided those sectors for our clients. We did not chase yield when others did. We do not use mutual funds in the traditional or leveraged way. We only use ETFs for stock markets and mostly do our own credit research on each bond we buy for our clients.
The rules are simple. If you cannot see it, don’t buy it. If you do not understand it, don’t buy it. It you cannot trade it with liquidity, avoid it. If you violate any of these rules, make sure you are getting additional compensation for the risk you are taking. In Italy, these are now proven to be three sound principles. In the US, the same rules apply.
It is going to be an interesting week.