John Mauldin, Editor
Outside the Box
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Fear and rage must not be used as an excuse to destroy America’s core institutions
by: Martin Wolf
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By: Captain Hook
Why a Full-Blown Banking Crisis Is Inevitable
Italy is on the verge of a massive banking crisis.
You’ve probably heard that Italian banks are in serious trouble. They’re sitting on more than €360 billion worth of non-performing loans (NPL). These are loans where the borrower has stopped paying.
According to Bloomberg, the NPL ratio for five of Italy’s biggest banks is more than double that of the average European bank.
• Italian bank stocks have also nosedived this year…
UniCredit, Italy’s biggest bank, is down more than 45%. Banco Popolare, another major Italian bank, is down 74%. Banca Monte dei Paschi di Siena, Italy’s third biggest bank (and the oldest surviving bank in the world), has plunged 87%.
This is a serious red flag. After all, we’re talking about the cornerstones of Italy’s banking system.
And, right now, these stocks are trading like a banking crisis is around the corner.
In fact, that crisis may have just begun…
• On Monday, Italy’s government said it’s going to bail out its troubled banks…
A "bailout" is when a government injects money into its banking system to keep it from collapsing. If the term sounds familiar, it’s because the U.S. government bailed out several “too big to fail” banks during the 2008 financial crisis.
The Financial Times shared the details of the bailout yesterday:
The Italian government has asked parliament to authorise up to €20bn to prop up the country’s most fragile banks, as it prepares to mount a possible state rescue of Monte dei Paschi di Siena, its third-largest lender, by the end of the week.
• Monte dei Paschi is Italy’s most troubled bank…
About 35% of its loans are non-performing. It has about five times as many bad loans as the average European bank.
This morning, the bank warned that it could run out of cash within four months. Previously,
representatives of the bank said it had enough cash to last 11 months.
Monte dei Paschi is running out of time. And a bailout looks like the only thing that can keep it from failing. There’s just one problem…
• A bailout won’t actually fix Italy’s broken banking system…
At best, it will buy Italy time. Bloomberg wrote this morning:
Italian banks need at least 52 billion euros ($54 billion) to clean up their balance sheets, much more than the rescue package proposed Monday by the government...
The Italian government asked parliament this week to increase the public borrowing limit by as much as 20 billion euros to potentially backstop Monte Paschi and other lenders. The rescue package needs to be closer to 30 billion euros to solve Italy’s bad-debt crisis, according to Paola Sabbione, a Milan-based analyst at Deutsche Bank AG. That conclusion assumes UniCredit and some other lenders can raise about 20 billion euros through capital markets, asset sales and profit retention -- leaving the government to fill the rest of the 52-billion-euro hole.
In other words, Bloomberg is saying the current bailout plan isn’t nearly big enough. But we don’t think a bigger bailout would make much of a difference.
• Crisis Investing editor Nick Giambruno says Italy’s banking system is broken beyond repair…
Nick, who’s been following the situation in Italy for months, wrote me an email yesterday with the details:
Italy will go into more than $20 billion in debt to prop up its banking system. That is not going to plug the hole of $400 billion and growing of bad loans. It will just kick the can down the road… and not for long. Soon they will need another bailout. Banca Monte dei Paschi has been bailed out twice already to no avail.
It’s not just Italy’s banking system that investors need to be worried about, either…
• Italy’s government is drowning in debt, too…
Italy is one of the most indebted countries on the planet. It’s more than $2.4 trillion in debt, and its debt-to-GDP ratio is north of 130%. For comparison, the US debt-to-GDP ratio is 104%.
What’s more, Nick says Italy’s sky-high debt-to-GDP ratio actually underestimates the severity of the situation:
GDP measures a country’s economic output, but that’s highly misleading. Mainstream economists count government spending as a positive when calculating GDP. But we all know governments don’t create wealth. They only steal and destroy it.
He says a more honest measure of GDP would exclude government spending from economic output.
If you did this, the world would see that Italy’s government is dead broke. Nick continues:
Government spending makes up more than 50% of Italy’s GDP. If you counted this as negative, Italy’s government would appear hopelessly insolvent.
I don’t see how it’s possible for the Italian government to extract enough in taxes from the productive part of the economy—which has been stagnant for over 15 years—to ever pay back what it’s borrowed.
• Investors have yet to “price in” how bad things really are in Italy…
Nick goes on:
Italian government bonds are trading near record-low yields. More than $1 trillion worth of Italian bonds actually have negative yields. If you owned one of these bonds, you would actually have to pay to lend Italy’s government money. That’s not how the bond market is supposed to work.
Given the huge risks associated with Italy’s bankrupt government, the yields on Italian government bonds should be trading near record highs, not record lows.
It’s a bizarre and perverse situation.
Nick says it’s only a matter of time before reality sets in in Italy:
It’s inevitable that the Italian government bond bubble will burst and soon. But the European Central Bank can put off the day of reckoning temporarily buy buying billions of dollars' worth of Italian debt.
• Nick has encouraged his readers to short Italian government bonds…
Shorting is when you bet against an asset. If the asset loses value, you make money.
According to Nick, this is a “no-brainer” trade:
Italian government bonds are, without a doubt, in super-bubble territory. It won’t be long before a pin pricks it and… pop.
You, too, can flip Italy’s debt crisis into profits by signing up for Crisis Investing today. We’ll even give you a full 120 days to decide if the service is right for you. Click here to get started.
Chart of the Day
The euro just hit a 13-year low.
Today’s chart shows the exchange rate between the euro and the U.S. dollar. When this ratio is rising, it means the euro is strengthening against the dollar. When it's falling, it means the euro is weakening against the dollar.
You can see the euro started plunging against the U.S. dollar in early 2014. It then traded sideways for over a year before it started falling again.
Today, one euro “buys” $1.04 USD. The euro hasn’t been this weak since 2003. But Nick thinks the euro is headed even lower from here. He explained why earlier this month in the International Man Communiqué:
If it breaks below its March 2015 low of $1.046, it would pave the way for it to test parity with the US dollar (which hasn't happened since late 2002). If that happens, look out below.
In other words, the euro just broke below a critical support level. This tells us that it will likely keep falling. That’s bad news for everyday Europeans. But it’s great news for Nick’s readers…
You see, Nick recommended shorting the euro in the August issue of Crisis Investing. In just four months, his readers are already up 18%. But they could see much bigger gains if the euro keeps falling like Nick expects.