Why a Full-Blown Banking Crisis Is Inevitable

by Doug Casey, Casey Research:

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…

Nick explains:

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.

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