Italy has a banking crisis — so presumably it had the kind of crazy boom that typically leads up to a financial crash.
Such as, shoe-box apartments in Turin selling for a million euros. Bankers swilling Asti Spumante and snorting coke in the lap-dancing clubs of Milan. Ferrari dealers selling new two hundred thousand euro cars to teenagers with no credit checks. Old ladies slipping out of mass to place orders for penny shares on their smart phones.
But hold on. Italy has seen nothing of the kind. In the last decade, growth has been completely flat. House prices are actually falling. The equity markets have been about as exciting as one of Angela Merkel’s campaign rallies. In effect, Italy now has the hangover, without ever having been to the party.
In truth, Italy doesn’t really have a banking crisis at all. It has a currency crisis. The euro EURUSD, +0.0091% sucked the demand out of the economy and killed growth. The result? Bad debts have soared. Now it is stopping the government from bailing out its financial sector. Prime Minister Matteo Renzi can paper over the cracks, but until the country finds a way to live with the euro, or a way out of the eurozone, none of its problems will have been solved.
After a month of fretting about Brexit, which so far has turned out to be a non-event, the markets are now worrying about the collapse of the Italian banking system — and rightly so.
According to IMF figures, the country’s banks have 360 billion euros of bad loans, equivalent to 18% of gross domestic product. Share prices of all the major banks have been in freefall. UniCredit UCG, +2.58% , the country’s largest bank, has seen its shares drop by more than 60%. Banco Popolare di Milano PMI, +0.16% down by more than 60% since the start of the year, and so is Intesa Sanpaolo ISP, +0.87% .
Those are the kind of losses that suggest a bank is about to run into serious trouble. Even the governor of the Bank of Italy, Ignacio Visco, said earlier this month that the sector would need some form of state aid.
We have, of course, been here before. Banks make lots of irresponsible loans. They load up companies, property developers and consumers with debts, and then when the markets turn down, a lot of those loans turn sour and can’t be repaid.
That is what happened in the U.S. and the U.K. in 2008 and 2009, and it is a story that has been played out in many other countries before and since. In Italy, there is a twist, however. There was never much sign of the irresponsible lending.
If Italy has been though a speculative bubble, of the sort that was always likely to burst, it is very hard to find much evidence of it.
House prices? They are usually a sure sign of froth in the system. But, according to Eurostat data, Italian property prices are down by 1.6% over the past year. The stock market? That has not exactly been in bubble territory either. At 16,700 the Milan index I945, +0.18% is a long way down on the 25,000 it touched last year, and is barely up on the last three years. How about consumer lending? According to European Central Bank figures, that has been growing this year at a rate of around 1% annually.
In reality, Italian banks have been managed in a perfectly prudent and sensible manner. The problem is that the economy has got so much smaller. Growth has hit a wall, and it appears impossible to revive it. In 2015, the Italian economy expanded by less than 1%. In fact, Italy’s economy is still 8% smaller than it was before the 2008 crash, and no bigger than it was back in 1999 when it joined the euro.
It is not hard to work out what is going on. When the economy is that sluggish, lots of small companies struggle to pay back their debts. Likewise, mortgages turn sour and so do consumer loans. A debt that looked perfectly manageable a decade ago is not going to look so healthy 10 years on when the economy is almost a tenth smaller, unemployment is far higher, and real wages have been falling relentlessly.
So debt levels have risen inexorably, just because the economy is treading water.
That has led to a tidal wave of bad loans. If anything, it is surprising not that the banks are in trouble, but that it has taken so long for the problems to emerge.
In fact, what Italy has is a euro crisis, not a banking crisis. The single currency has destroyed the competitiveness of what, 20 years ago, was a perfectly healthy manufacturing sector. It has sucked demand out of the economy, and hammed consumer spending.
It gets worse. Eurozone rules introduced at the start of this year mean bond holders, which in Italy means lots of private investors, have to be “bailed-in” to a rescue. The government cannot simply rescue banks that have run into trouble. It has to make sure that private investors take a hit as well — and since many of those are ordinary savers, that will mean even steeper declines in spending, and leave the economy in even worse shape.
As any doctor will tell you, unless you get the diagnosis right there is no hope of successful treatment.
Right now, the ECB and the eurozone finance ministers are operating as if this were a banking crisis like any other. Fix the banks, stop the irresponsible lending, and everything will be OK again. But that is simply not true.
Even if the banks are fixed this time around, in a stagnant economy they will just run into trouble again in a few years time.
Italy is trapped in the worst of all possible worlds — and it has become a vivid lesson in how dysfunctional the euro has become.