Fleeing from Italy

Carmen Reinhart
Matteo Renzi campaigning for constitutional reform

CAMBRIDGE – Italy’s referendum on December 4 will give voters the opportunity to approve or reject what some have described as the country’s most extensive constitutional reforms since the abolition of the monarchy at the end of World War II. Yet it may be the fact that Italy’s three opposition parties all favor exiting the euro that explains why Prime Minster Matteo Renzi has promised to resign if voters reject the reforms.
Understandably, after the surprise victory in June of the “Leave” campaign in the United Kingdom’s Brexit referendum, and of Donald Trump in the United States’ presidential election, no one has much faith in polls in advance of the Italian vote. There is, however, a disquieting real-time poll of investors’ sentiment: capital flight from Italy has accelerated this year.
There is a recent precedent for this. In the summer of 2015, Greece’s short-lived default on its International Monetary Fund loan and the introduction of capital controls and deposit-withdrawal restrictions were at the center of the eurozone drama. Tensions between the Greek and German governments ran high, and speculation about whether Greece would remain in the eurozone escalated.
The stage has now shifted to the much larger Italian economy. In the current environment of uncertainty, yield spreads on Italian bonds have widened to about 200 basis points over German bunds.
Economic and political conditions in the two debt-laden southern European economies differ in important respects; but there are also similarities. Economic growth in both countries has lagged far behind other advanced economies for more than a decade, but most markedly since the Global Financial crisis of 2008-2009. According to IMF estimates, real per capita income in Italy is about 12% below what it was in 2007, with only Greece faring worse.
The problem of bank insolvency, endemic in Greece, where nonperforming loans account for more than one-third of bank assets, is not as generalized in Italy. Still, the uncertain resolution of Italy’s third-largest bank, Monte dei Paschi, together with the Italian government’s limited resources to deal with weak banks, has fueled unease among depositors. Bankers also warn that the plan for Monte dei Paschi’s rescue may be jeopardized by the December referendum, which could trigger another round of decline in share prices.
But, for all the talk of a looming banking crisis, the balance-of-payments crisis already underway in Italy since the first half of 2016 is the main factor driving the real-time poll of investors. Prior to the adoption of the euro, an unsustainable balance-of-payments position in Italy (as in other countries with their own currencies) would typically spur the central bank to raise interest rates, thereby making domestic financial assets more attractive to investors and stemming capital flight. With the European Central Bank setting monetary policy for the eurozone as a whole, this is no longer an option for Banca d’Italia.
Central Banks in countries facing a run on their currencies may also decide to allow a depreciation and let the markets chart the exchange rate’s course, rather than trying to “defend” some predetermined parity. This, too, is an obsolete option for Italy. While the euro can fluctuate freely vis-à-vis other currencies, there is no “Italian” euro to depreciate versus a “German” euro. If capital is flowing out of Italy and into Germany, there is no scope for an Italian depreciation, as would have occurred prior to the common currency.
Policymakers have also sometimes introduced capital controls to slow, if not stop, capital flight during a balance-of-payments crisis. Greece and Cyprus within the eurozone, and Iceland outside it, resorted to this option in response to extreme duress. But the free movement of financial capital within the eurozone is a fundamental principle of the common currency’s design, and Italy is not at the point of abrogating it, at least for now.
If interest rate hikes, depreciation or devaluation of the currency, and controls on financial outflows are not viable options, what can a country’s central bank do when faced with accelerating capital flight? If it is not part of a currency union, it can resort to market intervention to support its currency, using and losing its foreign-exchange reserves in the process. Saudi Arabia’s massive reserve losses in the wake of falling oil prices reflect this policy response.
italian capital outflows
Within the eurozone, such reserve losses are automatic under Target2, the real-time gross settlement system for the euro. If a country has run out of reserves, its central bank automatically borrows to maintain the intraeuro peg. For a country experiencing capital flight (as much of the eurozone periphery has at various points since 2008), this implies a progressively more negative Target2 balance. As of September (the most recent data available), Italy’s Target2 deficit is above 20% of GDP – its worst reading to date (see figure). By some of the standard definitions, these are crisis-level reserve losses (shaded in the figure).
Ireland’s recent experience establishes an encouraging precedent for reversing this kind of downward spiral. For Italy, with its deeply divided political environment, engineering such a reversal will require a massive policy effort – and possibly a large dose of luck.


Funding the Rebels in Myanmar

The Chinese government is allowing domestic fundraising for Myanmar rebel fighters.

By Brendan O’Reilly

Ethnic Chinese rebels in northern Myanmar are launching attacks against the Myanmar military.

More interestingly, this armed group is allowed to openly raise funds in China. This unprecedented fundraising would be impossible without some degree of acquiescence by the Chinese state, and this acquiescence indicates a realignment of Chinese strategy towards its perpetually unstable southern neighbor.

Beijing now appears to be increasing its influence and support to non-state actors in Myanmar.

In the long term, China wants to cement its hold over Myanmar and use the country’s strategic position to decrease Chinese reliance on sea-bound trade. A more proactive stance in the region also would help Beijing rally nationalism and distract its population from pressing domestic economic issues.

Beijing’s interest in Myanmar stems from the geographic constraints pertaining to major trade routes.

The Chinese economy is hugely dependent on trade by sea. China imports more energy resources than any other country, and most of these resources must pass through bottlenecks in the Strait of Malacca and the disputed South China Sea.

Blocked by the U.S. and its allies in the Western Pacific, China sees involvement in Myanmar’s internal conflict as a means of achieving some degree of strategic depth in the region. Myanmar is the historic overland link between the Indian subcontinent, Southeast Asia and southwest China.

Myanmar soldiers patrol in Laukkai, the main city in the Kokang region of northern Myanmar, in Shan state, on Feb. 16, 2015. AFP/Getty Images

The rebel militias have launched their offensive in a crucial area. Fighting is concentrated near the town of Muse, at the main border crossing with China. Two key pipelines, operational since 2014, run through this area, bringing oil and gas from Myanmar’s Indian Ocean coast to southwest China.

A paved highway links Muse to Mandalay, Myanmar’s second largest city in the lowlands along the Irrawaddy River, the economic and political heartland of the Bamar ethnic majority.

The recent round of fighting in Myanmar began a few days ago when four rebel groups launched coordinated attacks against government forces near the Chinese border. These groups include the Kokang Army, Kachin Independence Army, Arakan Army and Ta’ang National Liberation Army, who now have formed an alliance. According to the Myanmar Peace Monitor, these groups have roughly 18,000 fighters combined. Most larger rebel armies along the mountainous Sino-Myanmar border have signed peace accords with the central government within the last two years, but these four groups have rejected the process. Myanmar has fought various ethnic rebels nearly continuously since its independence from the U.K. in 1948.

All four factions currently launching attacks against the state are ethnic rebels, but the Kokang Army is unique in that it is made up primarily of ethnic Chinese. They are the remnants of Ming dynasty loyalists who fled China into what is now northern Myanmar over 400 years ago to set up a mini-state eventually incorporated into British Burma. The Kokang Army is the only currently active armed rebel group in the world composed primarily of ethnic Chinese.

This gives it a huge advantage in directly selling its struggle to the Chinese population.

The Kokang Army, which controls mountainous territory along the Sino-Myanmar border, is now openly raising money and propagandizing on Chinese social media. These activities have the apparent acquiescence of Chinese state censors. The Kokang Army also has bank accounts for soliciting donations in southwestern China’s Yunnan province, just across the border from Myanmar. According to the Kokang Army’s Chinese-language websites and social media, sympathetic Chinese citizens from across the country have donated to their cause. So far, the numbers are not huge: The group claims to have raised roughly $20,000 since June 2016.

Beijing has maintained relations with various ethnic rebels in the mountainous regions of Myanmar near the Chinese border, where groups operate as de facto states. However, it is entirely unprecedented for a rebel group waging war against a neighboring government to be allowed to openly raise money from Chinese citizens.

The Chinese government has previously pledged non-interference in Myanmar’s entrenched ethnic conflicts, although it has hosted negotiations between various groups of ethnic rebels and the central government. Myanmar government spokespeople have previously accused Beijing of showing favoritism to the ethnic rebels in these talks. Beijing expresses discontent with the occasional spillover of cross-border violence and refugee inflows from the perpetually restive borderlands.

Chinese aid to armed groups in Myanmar is significant because it confirms our expectations of China’s behavior in its near abroad going forward. The U.S. Navy and the East Asian archipelago block China in the Western Pacific. On most of China’s land borders, the People’s Liberation Army is limited by terrain from conducting large-scale military operations. This means that China’s best option for enhancing its position is to get involved in its neighbors’ domestic politics. This is now coming to fruition in Myanmar, which is particularly vulnerable due to its plethora of armed non-state actors. As nationalism strengthens globally, Beijing will increasingly portray itself as the protector of ethnic Chinese worldwide. Tellingly, Chinese state-run media has noted that many Chinese are calling online for Beijing to support the Kokang Army.

China has made great investments in its area-denial capabilities, but Beijing cannot hope to challenge U.S. Naval dominance at least for many decades. It is also constrained by Japanese maritime forces in the event of a conflict in the Western Pacific. Control over Myanmar would allow for direct overland access to the Indian Ocean. Chinese investments in ports and overland transport routes in Pakistan are largely driven by the same imperatives.

Although China has generally enjoyed amicable ties with the current Myanmar government and has deep economic influence over the country, that influence has declined in recent years.

During the decades of open military rule, China was Myanmar’s main economic and political partner. However, with recent liberalization and the attendant lifting of economic sanctions, Myanmar is increasingly reaching out to the U.S. and India. Influence over ethnic rebels in Myanmar’s north allows China to hedge its bets in the country and place pressure on the government.

The Chinese state is not so incompetent as to let neighboring rebels raise funds in its territory without its knowledge. This is therefore an intentional move that aligns with China’s long-term imperative of increasing leverage over its neighbors by any means necessary, and its need for strategic depth away from the Western Pacific.

If This Happens, Italy’s Banking System Becomes “Insolvent”

Justin Spittler

Europe is “screwed.”

That’s what Steve Eisman thinks, at least. If the name rings a bell, it’s because Eisman was one of the few major investors who saw the last housing crisis coming.

He famously made a huge bet against the U.S. housing market. When housing prices tanked, Eisman pocketed more than $1 billion. The actor Steve Carrell played Eisman in the Oscar-winning film The Big Short.

A few weeks ago, Eisman hinted at his new big short: Italian banks. Reuters reported yesterday:

"Nobody is going to invest in the Italian banks unless they trust their balance sheets," said Eisman, adding that Italian lenders have been "very slow" to recapitalize and sell off troubled assets.

"In the Italian system, the banks say (assets) are worth 45-50 cents in the dollar. But the bid price is 20 cents. If they were to mark them down, they would be insolvent."

In other words, Eisman thinks Italy’s banking system is a ticking time bomb. And it’s only a matter of time before the “market” realizes this. He told the British newspaper The Guardian:

Europe is screwed. You guys are still screwed.

• Eisman isn’t the only one betting against Italian banks, either…

Reuters reported:

Data from the Italian market regulator shows "significant short positions" in Banco [sic] Popolare Di Milano and Banca Carige, while the regulator has restricted short-selling in shares of floundering Monte dei Paschi since July…

There is also evidence that investors have taken short positions in Italian government debt on a scale not seen since the euro zone debt crisis of 2011/2012.

• Bill Gross is worried about Italy’s banking system, too…

Gross is one of the world’s most respected investors. He founded PIMCO, one of the world’s biggest money managers, and now runs Janus Capital. You may also know Gross by his nickname, “The Bond King.”

This morning, Gross told Bloomberg that Italy is becoming a “basket case” due to its troubled Banks.

• In short, Italy is teetering on the edge of a Cliff…

If a banking crisis unfolds, Italians and people across Europe will undoubtedly suffer. But an Italian banking crisis could also reach you if you live on the other side of the world.

We’ll explain why today. We’ll also tell you about an event taking place two days from now that could set off a full-blown Italian banking crisis.

But let’s first look at why Eisman, Gross, and so many others are worried about Italy.

• Italian banks are in worse shape today than they were before the 2008–2009 financial crisis…

The Financial Times reported last week:

The woes of the banks stem from the Italian economy, which never recovered from the most recent crisis. Gross domestic product per head is 9 percent smaller in real terms than it was in 2007 and is stuck near the levels of two decades ago. Italy staggers under an ageing population and the second highest public debt load in Europe, at more than 130 per cent of GDP.

That’s not the only problem…

According to Business Insider, the country’s banks are sitting on €360 ($384) billion worth of impaired loans. About €200 ($213) billion of those loans are “non-performing,” meaning they’ll likely never be paid back.

For perspective, Italian banks have €225 ($240) billion in equity on their books. In other words, Italy’s banking system is drowning in debt.

• Italy’s biggest banks are seeking life support…

The Financial Times explains:

UniCredit, the country’s largest bank, is seeking to raise €13bn capital, and Monte dei Paschi, its most troubled large bank, may close a €5bn combined debt-for-equity swap and capital increase this week. But these sums are small compared with the system’s needs and the worst problems are concentrated in the smaller banks.

But there’s a problem. Italy’s government might not be able to stop its troubled banking system from collapsing under the weight of its own debt. The Financial Times went on:

If the government were to inject capital into the banking system, EU rules would require — at the very least — that subordinated creditors be converted to shareholders. This would be politically explosive.

Italian banks have long sold their own shares and debt to their retail customers as an attractive alternative to savings products, a disgraceful practice that should never have been allowed. It means that ordinary Italians, many in retirement, have already suffered as bank shares have fallen. They will suffer much more in a bail-in.

What’s worse, Italy is running out of time…

• Italy will hold an important constitutional referendum on Sunday…

If Italy votes “Yes,” Italy’s current government will stay in power.

If it votes “No,” a new radical government could rise to power in Italy. And MarketWatch reports this could trigger “a possible chain reaction of political upheaval, market instability and economic uncertainty.”

A “No” vote could also accelerate the banking crisis in Italy. Business Insider explained:

Now comes the nightmare scenario: If Italian premier Matteo Renzi loses his constitutional reform referendum on December 4, the markets may turn against Italy. The referendum asks whether Italy should reduce the power of its Senate and concentrate more power in Rome vs. the regions. A "yes" vote would make Italy's government less sclerotic. A "no" vote leaves the status quo in place.

Put another way, Italy’s government could have a tough time saving its banking system if the Italian people vote “No” two days from now. And, based on the latest polls, it looks like Italy will go in that direction.

• The European Central Bank (ECB) is bracing for the worst…

Reuters reported on Tuesday:

The European Central Bank is ready to temporarily step up purchases of Italian government bonds if the result of a crucial referendum on Sunday sharply drives up borrowing costs for the euro zone's largest debtor, central bank sources told Reuters.

The ECB could use its 80-billion-euro ($84.8 billion) monthly bond-buying programme to counter any immediate, further spike in bond yields after the vote, smoothing market moves and supporting bonds, according to four euro zone central bank sources who asked not to be named.

Unfortunately, emergency measures by the ECB won’t prevent an Italian banking crisis. At best, they’ll buy Italy and the rest of Europe time.

• We encourage you to take steps to protect your wealth…

The first thing we encourage you to do is own physical gold. As we like to point out, gold is real money. It’s preserved wealth for centuries and through every kind of financial crisis.

It will do the same if Italy’s banking system starts to unravel. The price of gold could even shoot through the roof if problems in Italy’s banking sector “daisy chain” across Europe and around the world.

• You can also turn this crisis into a money-making opportunity like Eisman and others have…

Some of our readers have already done this. That’s because Nick Giambruno, editor of Crisis Investing, made a bold bet against Europe in August.

He told his readers to short (bet against) the euro, the official currency of Italy and the rest of the European Union. In just three months, Nick’s euro short is up 13%.

But his readers could see much bigger gains if Sunday’s vote goes as expected.

Nick’s so convinced of this coming crisis that he recently doubled down on his bet against Italy.

This time, he shorted Italian government bonds. Like the euro, the value of these bonds could plunge if Italy’s banking system starts to crack.

Chart of the Day

Italian banks are buried under a mountain of bad debt.

Today’s chart shows the percentage of non-performing loans (NPL) for five of Italy’s biggest banks—UBI Banca, UniCredit, Banca Intesa, Banco Popolare, and Banca Monte dei Paschi di Siena. (Again, these are loans where the borrower has stopped paying the bank.) The column on the far left is the average NPL ratio for other European banks.

You can see that Italy’s banking system is in far worse shape than the rest of Europe. Its banks have about twice as many bad loans as the average European bank.

These efforts might postpone a banking crisis in Italy. But they won't fix Italy’s problems. You see, Italy’s banking system is broken beyond repair at this point. Like Eisman suggested, it’s only a matter of time before the rest of the world wakes up to this.

Don’t Bank on Relief for These Lenders

Investors shouldn’t count on lighter capital requirements for biggest U.S. banks

By Aaron Back

Banks have rallied since the election, in part because investors think they might benefit from a lighter regulatory touch. A look at two of the people who could shape that policy shows that investors might be a bit too optimistic.

Given President-elect Donald Trump’s lack of experience and ever-changing positions, the people he puts in place are likely to exert significant influence on policy. One is Jeb Hensarling, chairman of the House Financial Services Committee and a potential candidate for Treasury secretary. Even if he stays in Congress, he will be instrumental in shaping any new bank legislation.

Another person to watch is Thomas Hoenig, who is vice chairman of the Federal Deposit Insurance Corp. Mr. Hoenig’s name has been making the rounds as a possible pick for Federal Reserve vice chairman for supervision. This regulatory role was never filled by President Barack Obama, but its duties have been de facto filled by Fed governor Daniel Tarullo.

Both men have argued publicly that holding more loss-absorbing equity capital is the best way to make systemically important banks more resilient. Mr. Hensarling has proposed legislation that would exempt banks from a broad range of regulations in exchange for holding higher levels of capital.

Specifically, he focuses on the “leverage ratio” of tangible equity to total assets plus off-balance-sheet exposures. This would be more stringent than the current regulatory standards, which measure capital against risk-weighted assets. To qualify for relief, Mr. Hensarling wants banks to maintain “tangible equity,” defined in the proposal as Tier 1 common equity plus preferred shares, equivalent to 10% of total assets and exposures.

Calculations by The Wall Street Journal show that none of the six biggest banks in the U.S. would qualify for regulatory relief under this standard. Collectively, they would fall short by about $115 billion of equity capital. This estimate could undercount the amount of needed capital because it is based on total assets and doesn’t take into account off-balance-sheet exposures.

 J.P. Morgan Chase is short by the most, about $44 billion. But  Morgan Stanley’s shortfall is biggest relative to its size, at 18% of its market capitalization. The need to issue shares or cut dividends and buybacks to get to the standard suggests they would hesitate to make the trade, even in exchange for substantial regulatory relief.

Mr. Hoenig hasn’t proposed anything so specific, but in speeches he has argued against lowering capital requirements for systemically important banks. He has also favored use of the more stringent leverage ratio and tangible equity capital. Mr. Hensarling’s proposals cite Mr. Hoenig’s arguments for inspiration.

There are other reasons why big banks are rallying, including higher interest rates and trading volumes. But investors hoping for increased capital returns should temper expectations.

Paris Highway Robbers Target Qatari Sisters in $5.3 Million Heist


PARIS — Two well-heeled Qatari sisters arrived on Monday night with their family by private jet at Le Bourget airport, north of Paris, where they were met by a chauffeur-driven Bentley waiting to take them to their pied-à-terre in the French capital.
Soon after the two sisters, ages 60 and 61, and their driver set out on the A1 highway toward Paris, the car in front of them — a black Peugeot 406 with tinted windows — slammed on its brakes and forced the Bentley off the highway.
It was a holdup.
Three balaclava-wearing men emerged from the Peugeot. One of them attacked the Bentley’s driver with tear gas, while the two other assailants snatched the women’s luggage from the trunk. Within seconds the three bandits got back into their car and sped away with valuables worth an estimated 5 million euros, or about $5.3 million.
A police union spokesman said the brazen attack was clearly well planned.
“It doesn’t seem that this was random,” said the spokesman, Luc Poignant. “It was targeted.”
The heist is the latest in a series of robberies targeting wealthy tourists and famous visitors in and around Paris, to the dismay of many working in a tourism industry that was already suffering from the effects of last year’s terrorist attacks.
During Paris Fashion Week last month, several assailants burst into a luxurious apartment in the French capital, tied up the reality television star Kim Kardashian West, and robbed her at gunpoint of jewelry worth several million dollars. Last week, in the upscale 16th arrondissement of Paris, would-be robbers attacked the Bollywood actress Mallika Sherawat and her partner with tear gas before fleeing empty-handed.
The prosecutor’s office in Bobigny, which is handling the highway robbery case, said there were no known links to either of those Paris heists. But investigators were not ruling out a possible connection to the robbery last month of a French businessman, Philippe Ginestet, because the modus operandi was similar.
Mr. Ginestet, the chief executive of a French discount store chain, was leaving Le Bourget, the same airport where the Qatari women landed, in a taxi with his wife when another car hit them from behind, according to a report in Le Figaro newspaper.
When the taxi driver got out to look at the damage, three men wearing balaclavas emerged from their vehicle and stole the couple’s luggage, taking valuables worth about €100,000, or $106,000, including watches and jewelry, Le Figaro reported.
Mr. Poignant, the police spokesman, said the Qatari women’s driver had told the police that he had seen a handgun in the assailants’ Peugeot when he got out of his car to see what was going on, “but he was not held at gunpoint himself.” Neither sister was physically harmed, the prosecutor’s office said.
The valuables taken on Monday evening appeared to be mostly jewelry, the prosecutor’s office said, but it was not clear what exactly had been stolen. Mr. Poignant cautioned that the €5 million figure was an estimate provided by the victims, and that the actual value of the stolen goods might be different.
The A1 highway, which connects Paris to the Charles de Gaulle and Le Bourget airports, is notorious for these kinds of robberies, especially in a tunnel near the city’s entrance where assailants take advantage of slow traffic to target luxury cars that appear to be carrying foreign visitors, Mr. Poignant said.
In 2014, the convoy of a Saudi prince was traveling to Le Bourget when masked gunmen hijacked the lead car and made off with about $335,000 in cash, and in 2015 an art collector from Taiwan traveling by taxi was robbed of jewels worth several million dollars in the tunnel.
This month, Prime Minister Manuel Valls announced a government plan to spend about €10 million euros to deploy video surveillance cameras and other security measures near museums, monuments, hotels and other tourist-heavy areas in the Paris region, including the A1 highway.