Is the financial collapse of Italy going to be the final blow that breaks the back of Europe financially? Most people don’t realize this, but Italy is actually the third largest debtor in the entire world after the United States and Japan. Italy currently has a debt to GDP ratio of more than 120 percent, and Italy has a bigger national debt than anyone else in Europe does. That is why it is such a big deal that Italian voters have just overwhelmingly rejected austerity. The political parties led by anti-austerity candidates Silvio Berlusconi and Beppe Grillo did far better than anticipated. When you combine their totals, they got more than 50 percent of the vote. Italian voters have seen what austerity has done to Greece and Spain and they want no part of it. Unfortunately for Italian voters, it has been the promise of austerity that has kept the Italian financial system stable in recent months. Now that Italian voters have clearly rejected austerity, investors are fearing that austerity programs all over Europe may start falling apart. This is creating quite a bit of panic in European financial markets right now. On Tuesday, Italian stocks had their worst day in 10 months, Italian bond yields rose by the most that we have seen in 19 months, and the stocks of the two largest banks in Italy both fell by more than 8 percent. Italy is already experiencing its fourth recession since 2001, and unemployment has been steadily rising. If Italy is now “ungovernable”, as many are saying, then what does that mean for the future of Italy? Will Italy be the spark that sets off financial armageddon in Europe?
All of Europe was totally shocked by the election results in Italy. As you can see from the following excerpt from a Bloomberg article, the vote was very divided and the anti-austerity parties did much better than had been projected…
The results showed pre-election favorite Pier Luigi Bersani won the lower house with 29.5 percent, less than a half a percentage point ahead of Silvio Berlusconi, the ex-premier fighting a tax-fraud conviction. Beppe Grillo, a former comedian, got 25.6 percent, while Monti scored 10.6 percent. Bersani and his allies got 31.6 percent of votes in the Senate, compared with 30.7 percent for Berlusconi and 23.79 percent for Grillo, according to final figures from the Interior Ministry.
So what do those election results mean for Italy and for the rest of Europe?
Right now, there is a lot of panic about those results. There is fear that what just happened in Italy could result in a rejection of austerity all over Europe…
“I think the election results (or lack thereof) are a negative for the euro, which will likely keep the currency pressured for some time,” Omer Esiner, chief market analyst for Commonwealth Foreign Exchange, told me. But it’s not just the political uncertainty in Italy, he adds. “The shocking gains made by anti-establishment parties in Italy signal a broad-based frustration with austerity among voters and a decisive rejection of the policies pushed by Germany in nations across the euro zone’s periphery. That theme revives unresolved debt crisis issues and could threaten the continuity of reforms across other countries in the euro zone.”
And the financial markets have clearly interpreted the election results in Europe as a very bad sign. Zero Hedge summarized some of the bad news out of Europe that we saw on Tuesday…
Swiss 2Y rates turned negative once again for the first time in a month; EURUSD relatively flatlined around 1.3050 (250 pips lower than pre-Italy); Europe’s VIX exploded to almost 26% (from under 19% yesterday); and 3-month EUR-USD basis swaps plunged to their most liquidity-demanding level since 12/28. Spain and Italy (and Portugal) were the most hurt in bonds today as 2Y Italian spreads broke back above 200bps (surging over 50bps casting doubt on OMT support) and 3Y Spain yields broke above 3% once again. The Italian equity market suffered its equal biggest drop in 6 months falling back to 10 week lows (and down 14% from its end-Jan highs). Italian bond yields (and spreads) smashed higher – the biggest jump in 19 months as BTP futures volume exploded in the last two days.
Not that things in Europe were going well before all this.
In Spain, a major real estate company, Reyal Urbis, collapsed last week, leaving already battered banks on the hook for millions of euros in losses. Meanwhile, the government faces a corruption scandal and a steady stream of anti-austerity demonstrations. Thousands of people took to the streets again on Saturday, protesting deep cuts to health and other services, as well as hefty bank bailouts.
Life is no better in a large swath of the broader EU. In Britain, Moody’s cited the continuing economic weakness and the resulting risks to the government’s tight fiscal policy for its rating cut. In Bulgaria, where the government fell last week and the economy is in a shambles, rightists who joined mass demonstrations across the country burned a European Union flag and waved anti-EU banners. Other austerity-minded governments in the EU face similar murky political futures.
At this point, Europe is a complete and total economic mess and things are rapidly getting worse.
And that is really bad news because Europe is already in the midst of a recession. In fact, according to the BBC, the recession in the eurozone got even deeper during the fourth quarter of 2012…
The eurozone recession deepened in the final three months of 2012, official figures show.
The economy of the 17 nations in the euro shrank by 0.6% in the fourth quarter, which was worse than forecast.
It is the sharpest contraction since the beginning of 2009 and marks the first time the region failed to grow in any quarter during a calendar year.
But this is just the beginning.
The truth is that government debt is not even the greatest danger that Europe is facing. In reality, a collapse of the European banking system is of much greater concern.
Why is that?
Well, how would you feel if you woke up someday and every penny that you had in the bank was gone?
In the U.S. we don’t have to worry about that so much because all deposits are insured by the FDIC, but in many European countries things work much differently.
For example, just check out what Graham Summers recently had to say about the banking system in Spain…
It’s a little known fact about the Spanish crisis is that when the Spanish Government merges troubled banks, it typically swaps out depositors’ savings for shares in the new bank.
So… when the newly formed bank goes bust, “poof” your savings are GONE. Not gone as in some Spanish version of the FDIC will eventually get you your money, but gone as in gone forever (see the above article for proof).
This is why Bankia’s collapse is so significant: in one move, former depositors at seven banks just lost virtually everything.
And this in a nutshell is Europe’s financial system today: a totally insolvent sewer of garbage debt, run by corrupt career politicians who have no clue how to fix it or their economies… and which results in a big fat ZERO for those who are nuts enough to invest in it.
Be warned. There are many many more Bankias coming to light in the coming months. So if you have not already taken steps to prepare for systemic failure, you NEED to do so NOW. We’re literally at most a few months, and very likely just a few weeks from Europe’s banks imploding, potentially taking down the financial system with them. Think I’m joking? The Fed is pumping hundreds of BILLIONS of dollars into EU banks right now trying to stop this from happening.
Like Graham Summers, I am extremely concerned about the European banking system. Europe actually has a much larger banking system than the U.S. does, and if the European banking system implodes that is going to send huge shockwaves to the farthest corners of the globe.
But if you want to believe that the “experts” in Europe and in the United States have “everything under control”, then you might as well stop reading now.
After all, they are very highly educated and they know what they are doing, right?
But if you want to listen to some common sense, you might want to check out this very ominous warning from Karl Denninger…
I hope you’re ready.
Congress has wasted the time it was given by the Europeans getting things “temporarily” under control. But they didn’t actually get anything under control, as the Italian elections just showed.
Now, with the budget over there at risk of being abandoned, and fiscal restraint being abandoned (note: exactly what the US has been doing) the markets are recognizing exactly the risk that never in fact went away over the last couple of years.
It was hidden by lies, just as it has been hidden by lies here.
Bernanke’s machinations and other games “gave” the Congress four years to do the right thing. They didn’t, because that same “gift” also destroyed all market signals of urgency.
As such you have people like Krugman and others claiming that it’s all ok and that we can spend with wild abandon, taking our fiscal medicine never.
They were wrong. Congress was wrong. The Republicans were wrong, the Democrats were wrong, and the Administration was wrong.
Congress is out of time; as I noted the deficit spending must stop now, irrespective of the fact that it will cause significant economic damage.
For the past couple of years, authorities in the U.S. and in Europe have been trying to delay the coming crisis by kicking the can down the road.
By doing so, they have been making the eventual collapse even worse.
Would you pool your debt with a bunch of debt addicts that have no intention of reducing their wild spending habits? Of course you wouldn’t. But that is exactly what Germany is being asked to do. Increasingly, “eurobonds” are being touted as the best long-term solution to the financial crisis in Europe. These eurobonds would represent jointly issued debt by all 17 members of the eurozone. This debt would also be guaranteed by all 17 members of the eurozone. This would allow all countries in the eurozone to enjoy the same credit rating that Germany does, and borrowing costs for nations such as Greece, Portugal, Italy and Spain would plummet. But borrowing costs for Germany would rise substantially. In fact, it is being estimated that Germany could be facing an extra 50 billion euros a year in interest expenses. So over ten years that would come to about 500 billion euros. Needless to say, Germany is not thrilled about this idea. But new French President Francois Hollande is pushing eurobonds very hard, and he has the support of the OECD, the IMF and many top Italian politicians. In the end, this could be the key to the future of the eurozone. If the Germans give in and decide that they are willing to deeply subsidize their profligate neighbors indefinitely, then the euro could potentially be saved. If not, then this issue could end up shattering Europe.
It is easy to try to portray the Germans as the “bad guys” in all this, but try to step into their shoes for a minute.
If you had some relatives that were spending wildly and that had already run up $100,000 in credit card debt, would you be a co-signer on their next credit card application?
Of course not.
The recent elections in France and Greece made it abundantly clear that the populations of those two countries are rejecting austerity.
Instead, they want a return to the debt-fueled prosperity that they have always enjoyed in the past.
Unfortunately, they need German help to be able to do that.
That is why new French President Francois Hollande is pushing so hard for eurobonds. He wants the rest of the eurozone to be able to “piggyback” on Germany’s sterling credit rating so that everyone can return to the days of wild borrowing and spending.
But Germans greatly fear what a co-mingling of eurozone debt could eventually mean. Not only would Germany’s borrowing costs rise dramatically, but there is also a concern that the rest of the eurozone could eventually pull Germany down with them.
Austria, Finland and the Netherlands are also against eurobonds, but the key is Germany.
For now, Germany is not budging on the issue of eurobonds at all. The following is a statement that German Chancellor Angela Merkel made during a recent speech in Berlin….
“It’s just about not spending more than you collect. It’s astonishing that this simple fact leads to such debates”
And she is right.
Why is it so controversial to insist that people not spend more than they bring in?
But this is the problem that is created when you create a false lifestyle fueled by debt that goes on for decades. People become accustomed to that false standard of living and they throw hissy fits when that false standard of living begins to disappear.
The Germans don’t want to make great sacrifices just so the Greeks, the French and the Italians can go back to borrowing and spending wildly.
Why would the Germans want to do that?
And as a recent CNN article noted, German politicians believe that eurobonds are explicitly banned under existing EU treaties anyway….
“There is no way of introducing them under the current [EU] treaties. Indeed, there is an explicit ban on them,” one senior German official said, adding Berlin would not drop its opposition in the foreseeable future. “That’s a firm conviction which will not change in June.”
But politicians such as Hollande are complaining that austerity could seriously damage living standards throughout Europe.
And Hollande is right about that.
When you inflate your standard of living with borrowed money for many years, eventually there comes a time when you must pay a great price.
Anyone that has ever been in trouble with credit card debt knows how painful that can be.
It is shameful for the rest of Europe to be pleading and begging Germany to help them.
They should take care of themselves.
As I wrote about the other day, Greece would be much better off in the long run if it left the euro and created a new financial system based on sound financial principles.
But in the financial press all over the world there are calls for someone to come up with a “plan” to “rescue” Europe. For example, the following is from a recent Wall Street Journal article….
There have been two main responses to the crisis: austerity, and kicking cans down roads. Austerity, in case you haven’t noticed, is so last year. It’s out. Which means that unless something else is found, some other comprehensive plan, the other main response, can kicking, is going to run out of road.
Just about everybody backed the idea of eurobonds, except for the Germans, and since they’re the ones with all the money, they’re kind of the only ones whose vote counts anyway. So, it’s time to go to plan B. Only there’s no Plan B, and there’s no time, either.
If Germany does not agree to subsidize the rest of the eurozone, will that ultimately mean that the eurozone will be forced to break up?
And that would cause a huge amount of pain in the short-term.
But the euro never was a good idea in the first place. It was foolish to expect a monetary union to work smoothly in the absence of fiscal and political union.
And to be honest, the entire world would be a better place with less European integration. The EU has become a horrifying bureaucratic nightmare and it would be wonderful if the entire thing broke up.
But for now, the only thing that is in danger is the euro.
This week, former Greek Prime Minister Lucas Papademos admitted that the Greek government is considering making preparations for Greece to leave the euro.
Not only that, Reuters is reporting that top officials in the eurozone are now working on “contingency plans” for a Greek exit from the euro….
Each euro zone country will have to prepare a contingency plan for the eventuality of Greece leaving the single currency, euro zone sources said on Wednesday.
Officials reached the consensus on Monday afternoon during an hour-long teleconference of the Eurogroup Working Group (EWG).
As well as confirmation from three euro zone officials, Reuters has seen a memo drawn up by one member state detailing some of the elements that euro zone countries should consider.
So obviously a Greek exit from the euro has become a very real possibility.
A recent Bloomberg article detailed how a Greek exit from the euro could play out during the 46 hours that global financial markets are closed over the weekend….
Greece may have only a 46-hour window of opportunity should it need to plot a route out of the euro.
That’s how much time the country’s leaders would probably have to enact any departure from the single currency while global markets are largely closed, from the end of trading in New York on a Friday to Monday’s market opening in Wellington, New Zealand, based on a synthesis of euro-exit scenarios from 21 economists, analysts and academics.
Over the two days, leaders would have to calm civil unrest while managing a potential sovereign default, planning a new currency, recapitalizing the banks, stemming the outflow of capital and seeking a way to pay bills once the bailout lifeline is cut. The risk is that the task would overwhelm any new government in a country that has had to be rescued twice since 2010 because it couldn’t manage its public finances.
At this point, everyone is afraid of what is going to happen if Greece is forced to start issuing drachmas again. As CNBC is reporting, some big European corporations are already beginning to implement their own “contingency plans”….
Big tourism operators like TUI of Germany and Kuoni of Britain are demanding the addition of so-called drachma clauses to contracts with Greek hoteliers should the euro no longer be in use here. British newspapers are filled with advice columns for travelers worried about the wisdom of planning a vacation in Greece, or even Portugal and Spain, should the euro crisis worsen. Large multinational companies like Vodafone Group, Reckitt Benckiser and Diageo have taken to sweeping cash every day from euro accounts back to Britain to limit their exposure.
During an appearance on Meet The Press on Sunday, Jim Cramer of CNBC boldly predicted that “financial anarchy” is coming to Europe and that there will be “bank runs” in Spain and Italy in the next few weeks. This is very strong language for the most famous personality on the most watched financial news channel in the United States to be using. In fact, if Cramer is not careful, people will start accusing him of sounding just like The Economic Collapse Blog. It may not happen in “the next few weeks”, but the truth is that the European banking system is in a massive amount of trouble and if Greece does leave the euro it is going to cause a tremendous loss of confidence in banks in countries such as Spain, Italy and Portugal. There are already rumors that the “smart money” is pulling out of Spanish and Italian banks. So could we see some of these banks collapse? Would they get bailed out if they do collapse? It is so hard to predict exactly how “financial anarchy” will play out, but it is becoming increasingly clear that the European financial system is heading for a massive amount of pain.
Posted below is a clip of Jim Cramer making his bold predictions during his appearance on Meet The Press. He is obviously very, very disturbed about the direction that Europe is heading in….
But what is Europe supposed to do? Even though “austerity measures” have been implemented in many eurozone nations, the truth is that they are all still running up more debt. Are European nations just supposed to run up massive amounts of debt indefinitely and pretend that there will never been any consequences?
That is apparently what Barack Obama wants. During the G-8 summit that just concluded, Obama urged European leaders to pursue a “pro-growth” path.
Of course to Obama a “pro-growth” economic plan includes spending trillions of dollars that you do not have without any regard for what you are doing to future generations.
In Greece, the recent elections failed to produce a new government, so new elections will be held on June 17th.
Many EU politicians are trying to turn these upcoming elections into a referendum on whether Greece stays in the eurozone or not. If the next Greek government is willing to honor the austerity agreements that have been previously agreed to, then Greece will probably stay in the eurozone for a while longer. If the next Greek government is not willing to honor the austerity agreements that have been previously agreed to, then Greece will probably be forced out of the eurozone.
The following is what John Praveen, the chief investment strategist at Prudential International Investments Advisers, had to say about the political situation in Greece recently….
“If the pro-euro major parties fail to muster enough support to form a coalition and the radical left Syriza party and other anti-euro, anti-austerity parties secure a majority, the risk of a disorderly Greek exit from the Euro increases and could roil markets”
Right now, polls show the leading anti-austerity party, Syriza, doing very well. The leader of Syriza, Alexis Tsipras, has declared that he plans “to stop the experiment” with austerity and that what the rest of the eurozone has tried to do in Greece is a “crime against the Greek people“.
But the Germans do not see it that way. The Germans just want the Greeks to stop spending far more money than they bring in.
The Germans do not want to endlessly bail out the Greeks if the Greeks are not willing to show some financial discipline.
As we approach the June 17th elections, the financial markets are likely to be quite nervous. According to Art Hogan of Lazard Capital Partners, many investors are deeply concerned about how “sloppy” a great exit from the euro could be….
“Next week is only one of the four weeks we have to wait until the Greek election. Every utterance out of Greece makes us think about their [possible] exit and how sloppy that could be”
Most Greek citizens want to remain in the eurozone and most European politicians want Greece to remain in the eurozone, but it is looking increasingly likely as if that may not happen.
In fact, there are reports that preparations are rapidly being made for a Greek exit. According to Reuters, “contingency plans” for the printing of Greek drachmas have already been drawn up….
De La Rue (DLAR.L) has drawn up contingency plans to print drachma banknotes should Greece exit the euro and approach the British money printer, an industry source told Reuters on Friday.
And even EU officials are now acknowledging that plans for a Greek exit from the euro are being developed. The following is what EU Trade Commissioner Karel De Gucht said during one recent interview….
“A year and a half ago, there may have been the danger of a domino effect,” he said, “but today there are, both within the European Central Bank and the European Commission, services that are working on emergency scenarios in case Greece doesn’t make it.”
When these kinds of things start to become public, that is a sign that officials really do not expect Greece to remain a part of the euro.
And Greece is rapidly beginning to run out of money. According to a recent Ekathimerini article, the Greek government is likely to run out of money at the end of June….
The public coffers are seen running dry at the end of June, but this will depend on two key factors. First, revenue collection: In the first 10 days of May, inflows were about 15 percent lower than projected but there are fears that the slide may reach 50 percent. The GAO will have a picture for the first 20 days on May 23, while the last three days of the month are considered crucial, when 1.5 billion euros of the month’s budgeted total of 3.6 billion are expected to flow in.
Second, whether the IMF and EFSF installments are disbursed: This is not certain, as the decision will be purely political for both providers and evidently partly linked to political developments. Earlier this month the eurozone approved a disbursement 1 billion short of the 5 billion euros that were expected.
If Greece runs out of money and if the rest of Europe cuts off the flow of euros, Greece would essentially be forced to leave the euro.
So the last half of June looks like it could potentially be a key moment for Greece.
Meanwhile, the Greek banking system is struggling to survive as hundreds of millions of euros get pulled out of it. The following is from a recent CNN article….
The Greek financial system is straining hard for cash.
Consumers and businesses are making massive withdrawals from Greece’s banks — leading to concern the beleaguered nation could be forced out of the eurozone by a banking crisis even before its government runs out of cash.
Deposits are the lifeblood of any bank, and Greeks pulled 800 million euros out of the banking system on Tuesday alone, the most recent day for which figures are available.
If Greece does leave the euro and the Greek banking system does collapse, that is going to be a clear signal that a similar scenario will be allowed to play out in other eurozone nations.
That is why Jim Cramer, myself and many others are warning that there could soon be bank runs all over the eurozone.
And if the “house of cards” does come down in Europe, that is going to greatly destabilize the global derivatives market.
You see, the truth is that the global derivatives market is very delicately balanced. The assumption most firms make is that things are not going to deviate too much from what is considered “normal”.
If we do end up seeing “financial anarchy” in Europe, that is going to greatly destabilize the system and we could rapidly have a huge derivatives crisis on our hands.
And as we saw with JP Morgan recently, losses from derivatives can add up really fast.
Originally, we were told that the derivatives losses that JP Morgan experienced recently came to a total of only about 2 billion dollars.
Now, we are told that it could be a whole lot more than that. According to the Wall Street Journal, JP Morgan could end up losing about 5 billion dollars (or more) before it is all said and done….
J.P. Morgan Chase & Co. is struggling to extricate itself from disastrous wagers by traders such as the “London whale,” in a sign that the size of its bets could bog down the bank’s unwinding of the trades and deepen its losses by billions of dollars.
The nation’s largest bank has said publicly that its losses on the trades have surpassed $2 billion, and people familiar with the matter have said they could over time reach $5 billion.
And if Europe experiences a financial collapse, the losses experienced by U.S. firms could make that 5 billion dollars look like pocket change. The following is from a recent article by Graham Summers….
According to Reuters once you include Spain and Italy as well as Credit Default Swaps and indirect exposure to Europe, US banks have roughly $4 TRILLION in potential exposure to the EU.
To put that number in perspective, the entire US banking system is $12 trillion in size.
Interesting days are ahead my friends.
Let us hope for the best, but let us also prepare for the worst.
With each passing day, the banking crisis in Europe escalates. European banks are having their credit ratings downgraded in waves, bond yields are soaring and billions of euros are being pulled out of banks all across the eurozone. The situation in Europe is rapidly going from bad to worse. It is almost like watching air being let out of a balloon. The key to any financial system is confidence, and right now confidence in banks in Greece, Italy, Spain and Portugal is declining at an alarming rate. When things hit the fan in Europe, it is going to be much safer to have your money in Swiss banks or German banks than in Greek banks, Spanish banks or Italian banks. Millions of people in Europe are starting to realize that a “euro” is not necessarily always going to be a “euro” and they are starting to panic. The Greek banking system is already on the verge of total collapse, and at this rate it is only a matter of time before we see some major Spanish and Italian banks start to fail. In fact it has already been announced that the fourth largest bank in Spain, Bankia, will be getting bailed out by the Spanish government. It is only a matter of time before we hear more announcements like this. Right now, events are moving so quickly in Europe that it is hard to keep up with them all. But this is what usually happens in the financial world. When things go well, it tends to happen over an extended period of time. When things fall apart, it tends to happen very rapidly.
And at the moment, things across the pond are moving at a pace that is absolutely breathtaking.
The following are 18 signs that the banking crisis in Europe has just gone from bad to worse….
#1 Moody’s has announced that it has downgraded the credit ratings of 16 Spanish banks. Included was Banco Santander, the largest bank in the eurozone.
#2 Shares of the fourth largest bank in Spain, Bankia, dropped 14 percent on Thursday.
#3 Overall, shares of Bankia have declined by 61 percent since last July.
#4 Shares of the largest bank in Italy, Unicredit, dropped by about 6 percent on Thursday.
#5 According to CNBC, a Spanish bond auction on Thursday went very poorly….
The Spanish Treasury had to pay around 5 percent to attract buyers of three- and four-year bonds. The longer-dated paper sold with a yield of 5.106 percent, way above the 3.374 percent the last time it was auctioned.
#13 The Spanish government is becoming increasingly concerned about the bad loans that are mounting at major Spanish banks. The following is from a recent Bloomberg article….
The government has asked lenders to increase provisions for bad debt by 54 billion euros ($70 billion) to 166 billion euros. That’s enough to cover losses of about 50 percent on loans to property developers and construction firms, according to the Bank of Spain. There wouldn’t be anything left for defaults on more than 1.4 trillion euros of home loans and corporate debt.
Taking those into account, banks would need to increase provisions by as much as five times what the government says, or 270 billion euros, according to estimates by the Centre for European Policy Studies, a Brussels-based research group. Plugging that hole would increase Spain’s public debt by almost 50 percent or force it to seek a bailout, following in the footsteps of Ireland, Greece and Portugal.
#14 Civil unrest is rising to dangerous levels in Italy. The Italian government has assigned bodyguards to 550 individuals and has increased security at about 14,000 locations in response to recent violence related to the economic crisis.
#15 Governments all over Europe are rapidly making preparations for a Greek exit from the euro. The following is from a recent article in the Guardian….
The British government is making urgent preparations to cope with the fallout of a possible Greek exit from the single currency, after the governor of the Bank of England, Sir Mervyn King, warned that Europe was “tearing itself apart”.
#16 According to CNBC, the banking crisis in Europe is beginning to affect global trade….
The euro zone debt crisis is affecting trade as companies shy away from dealing with firms and banks in countries deemed at risk of contagion, a senior banker said on Thursday.
What we are all watching unfold right now is a complete and total financial nightmare for Italy. Italian bond yields are soaring to incredibly dangerous levels, and now the yield curve for Italian bonds is turning upside down. So what does that mean? Normally, government debt securities that have a longer maturity pay a higher interest rate. There is typically more risk when you hold a bond for an extended period of time, so investors normally demand a higher return for holding debt over longer time periods. But when investors feel as though a major economic downturn or a substantial financial crisis is coming, the yield on short-term bonds will often rise above the yield for long-term bonds. This happened to Greece, to Ireland and to Portugal and all three of them ended up needing bailouts. Now it is happening to Italy and Spain may follow shortly, but the EU cannot afford to bail out either of them. An inverted yield curve is a major red flag. Unfortunately, there does not seem to be much hope that there is going to be a solution to this European debt crisis any time soon.
We are witnessing a crisis of confidence in the European financial system. All over Europe bond yields went soaring today. When I finished my article about the financial crisis in Italy on Tuesday night, the yield on 10 year Italian bonds was at 6.7 percent. I awoke today to learn that it had risen to 7.2 percent.
But even more importantly, the yield on 5 year Italian bonds is now sitting at about 7.5 percent, and the yield on 2 year Italian bonds is about 7.2 percent.
The yield curve for Italian bonds is in the process of turning upside down.
If you want to see a frightening chart, just look at this chart that shows what has happened to 2 year Italian bonds recently.
Do phrases like “heading straight up” and “going through the roof” come to mind?
This comes despite rampant Italian bond buying by the European Central Bank. CNBC is reporting that the European Central Bank was aggressively buying up 2 year Italian bonds and 10 year Italian bonds on Wednesday.
So what does it say when even open market manipulation by the European Central Bank is not working?
Of course some in the financial community are saying that the European Central Bank is not going far enough. Some prominent financial professionals are even calling on the European Central Bank to buy up a trillion euros worth of European bonds in order to soothe the markets.
Part of the reason why Italian bond yields rose so much on Wednesday was that London clearing house LCH Clearnet raised margin requirements on Italian government bonds.
But that doesn’t explain why bond yields all over Europe were soaring.
The reality is that bond yields for Spain, Belgium, Austria and France also skyrocketed on Wednesday.
This is a crisis that is rapidly engulfing all of Europe.
But at this point, bond yields in Europe are still way too low. European leaders shattered confidence when they announced that they were going to ask private Greek bondholders to take a 50% haircut. So now rational investors have got to be asking themselves why they would want to hold any sovereign European debt at all.
There is no way in the world that any rational investor should invest in European bonds at these levels.
Are you kidding me?
If there is a very good chance that private bondholders will be forced to take huge haircuts on these bonds at some point in the future then they should be demanding much, much higher returns than this.
But if bond yields continue to go up in Europe, we are going to quickly come to a moment of very great crisis.
The following is what Rod Smyth of Riverfront Investment Group recently told his clients about the situation that is unfolding in Italy….
“In our view, 7% is a ‘tipping point’ for any large debt-laden country and is the level at which Greece, Portugal and Ireland were forced to accept assistance”
Other analysts are speaking of a “point of no return”. For example, check out what a report that was just released by Barclays Capital had to say….
“At this point, Italy may be beyond the point of no return. While reform may be necessary, we doubt that Italian economic reforms alone will be sufficient to rehabilitate the Italian credit and eliminate the possibility of a debilitating confidence crisis that could overwhelm the positive effects of a reform agenda, however well conceived and implemented.”
But unlike Greece, Ireland and Portugal, the EU simply cannot afford to bail out Italy.
Italy’s national debt is approximately 2.7 times larger than the national debts of Greece, Ireland and Portugal put together.
Plus, as I noted earlier, Spain is heading down the exact same road as Italy.
Europe has simply piled up way, way too much debt and now they are going to pay the price.
Global financial markets are very nervous right now. You can almost smell the panic in the air. As a CNBC article posted on Wednesday noted, one prominent think tank actually believes that there is a 65 percent chance that we will see a “banking crisis” by the end of November….
“There is a 65 percent chance of a banking crisis between November 23-26 following a Greek default and a run on the Italian banking system, according to analysts at Exclusive Analysis, a research firm that focuses on global risks.”
Personally, I believe that particular think tank is being way too pessimistic, but this just shows how much fear is out there right now.
It seems more likely to me that the European debt crisis will really unravel once we get into 2012. And when it does, it just won’t be a few countries that feel the pain.
For example, when Italy goes down many of their neighbors will be in a massive amount of trouble as well. As you can see from this chart, France has massive exposure to Italian debt.
Just like we saw a few years ago, a financial crisis can be very much like a game of dominoes. Once the financial dominoes start tumbling, it will be hard to predict where the damage will end.
Some believe that what is coming is going to be even worse than the financial nightmare of a few years ago. For example, the following is what renowned investor Jim Rogers recently told CNBC….
“In 2002 it was bad, in 2008 it was worse and 2012 or 2013 is going to be worse still – be careful”
Rogers says that the reason the next crisis is going to be so bad is because debt levels are so much higher than they were back then….
“Last time, America quadrupled its debt. The system is much more extended now, and America cannot quadruple its debt again. Greece cannot double its debt again. The next time around is going to be much worse”
So what is the “endgame” for this crisis?
German Chancellor Angela Merkel is saying that fundamental changes are needed….
“It is time for a breakthrough to a new Europe”
So what kind of a “breakthrough” is she talking about? Well, Merkel says that the ultimate solution to this crisis is going to require even tighter integration for Europe….
“That will mean more Europe, not less Europe”
As I have written about previously, the political and financial elite of Europe are not going to give up on the EU because of a few bumps in the road. In fact, at some point they are likely to propose a “United States of Europe” as the ultimate solution to this crisis.
But being more like the United States is not necessarily a solution to anything.
No, the real problem is government debt and the central banks of the western world which act as perpetual debt machines.
By not objecting to central banks and demanding change, those of us living in the western world have allowed ourselves to become enslaved to gigantic mountains of debt. Unless something dramatically changes, our children and our grandchildren will suffer under the weight of this debt for as long as they live.
Don’t we owe future generations something better than this?
Oh, how the mighty have fallen. In just a matter of days, two of Europe’s most venerable leaders have been toppled. George Papandreou was the third member of the Papandreou dynasty to be prime minister of Greece. Silvio Berlusconi had dominated Italian politics for nearly two decades. But now they are both heading out the door and the international media have been reporting on their resignations with the kind of enthusiasm that is normally reserved for sporting events. “Down goes Papandreou! Down goes Berlusconi!” If you didn’t know better, you would almost be tempted to think that some of the recent news reports were describing a boxing match. But this is what happens when debt problems spiral out of control. It is the leaders who take the fall. So will the resignations of Papandreou and Berlusconi help anything? Of course not. Europe is still headed for a financial collapse of epic proportions.
As I wrote about recently, it has been the fumbling of the Greek debt crisis by European leaders which has set the stage for the burgeoning financial crisis in Italy to go to a whole new level.
Once the Greek debt deal was announced, I warned that it would shatter confidence in the sovereign debt of the rest of the PIIGS and it would cause their bond yields to soar.
That is exactly what has happened.
The yield on 10 year Italian bonds (probably the most important financial number in the world at the moment) is now up to 6.7 percent.
Never before in the euro era has the yield on Italian bonds been as high as we have seen this week.
So why is this important?
Well, the reality is that Italy simply cannot afford to service its massive national debt when yields are this high.
We are officially in the danger zone.
Carl Weinberg, the chief economist at High Frequency Economics, recently said the following about what would happen if Italian bond yields go up into the 8 to 10 percent range….
“If it has to pay those yields to finance itself, Italy is dead, and the sovereign crisis just blew up”
So watch that number very carefully over the next few months.
Italy is being called “too big to fail, too big to save”. There is no way that Europe can afford Italy to crash, but there is also no way that the rest of Europe can put together enough money for a full scale bailout of Italy.
So there is panic in the air.
The Italian government is in a state of near chaos and over the past couple of weeks we have seen Berlusconi’s coalition break down. Now Berlusconi has agreed to resign, and the future of Italian politics is murky at best.
The following is how a Reuters article described the agreement for Berlusconi step down….
Berlusconi confirmed a statement from President Giorgio Napolitano that he would step down as soon as parliament passed urgent budget reforms demanded by European leaders after Italy was sucked into epicenter of the euro zone debt crisis.
The votes in both houses of parliament are likely this month and they would spell the end of a 17-year dominance of Italy by the flamboyant billionaire media magnate.
Many believe that the departure of Berlusconi is going to pave the way for brutal austerity measures to be imposed on the Italian people.
The Italians feel they’ve been humiliated by having to accept that monitors from the IMF will be arriving in the country this week to oversee a rise in pension ages, a sell-off of state assets and new rules to make jobs less secure.
Does that not sound like exactly what happened in Greece back near the beginning of their crisis?
In Greece, brutal austerity measures demanded by the EU and the IMF plunged the country into a depression, tax revenues plummeted, Greek debt exploded to even higher levels, bond yields soared into the stratosphere and the EU and the IMF demanded even more austerity measures be implemented.
Is the same sad story going to play out in Italy?
The Italians are definitely going to agree to some pretty significant budget cuts. But if bond yields keep rising, they are going to wipe out all of the savings from the budget cuts and then some.
This is why I keep preaching about the horror of the U.S. national debt over and over and over. If you don’t deal with it when you can, eventually interest rates rise to unbearable levels and a horror show quickly unfolds.
Anyway, right now Italy has a debt to GDP ratio of 118 percent. If they keep expanding that debt it is going to result in a financial nightmare, but if they try to implement strict austerity measures it is also going to result in a financial nightmare.
They are damned if they do and they are damned if they don’t.
Of course we should not forget about Greece.
The EU has been freaking out for quite a while about what to do about tiny little Greece.
Now that George Papandreou has been kicked to the curb, it looks like Lucas Papademos is going to be the next prime minister of Greece.
Papademos previously served as the governor of the Greek central bank, as a vice president of the European Central Bank and as a senior economist at the Federal Reserve Bank of Boston.
In other words, he would be the ideal choice of the international banking community.
Not that anyone is going to be able to do much for Greece at this point. Greece is a financial basket case, and unless someone gives them gigantic piles of money for free that is going to continue to be the case.
A year ago, the yield on 2 year Greek bonds was a bit above 10 percent. Today, the yield on 2 year Greek bonds is over 100 percent.
If you want to see what a financial meltdown looks like, just check out what is happening in Greece.
The rest of Europe is in panic mode too. For example, France is desperate to keep their AAA credit rating. In an article for the Telegraph, Ambrose Evans-Pritchard described the austerity measures that France is implementing in an attempt to head off a debt crisis of their own….
The belt-tightening plan — the second package since August, taking total cuts to €112bn — include a 5pc super-tax on big firms, a rise in VAT on restaurants and construction, and cuts on pensions, schools, health, and welfare. It is the latest squeeze in a relentless campaign of fiscal tightening across the eurozone.
In the end, all of this is too little, too late.
Europe is heading for a date with destiny. They have spent themselves into oblivion and now they are going to pay the price.
Some members of the financial community fear that a full-blown crisis could erupt at any moment. For example, according to Business Insider, Colin Tan of Deutsche Bank recently said that he believes that it is possible that “we could be in full crisis mode” by the time the week ends….
Its not inconceivable that we could be in full crisis mode by the end of this week. The situation with Italy feels increasingly like one that has little chance of materially improving until some extreme pressure is put on someone to act. It may not come to a head this week but the signs are not good that we can avoid an extreme situation emerging soon.
For those of you that are freaking out about now, don’t worry too much. A full-blown crisis is not going to happen this week.
But time is running out.
And when Europe comes apart, it is going to have a dramatic impact on the United States as well.
“About one-half of domestic bank respondents, mostly large banks, indicated that they make loans or extend credit lines to European banks or their affiliates or subsidiaries”
Big U.S. banks have a lot of exposure to European debt and to European banks. When the financial dominoes start to fall, a lot of those dominoes are going to be in the United States.
One of the biggest dangers to be concerned about are all of the credit default swap contracts that U.S. banks have written on European debt. Just check out what a recent article posted on the website of MSNBC had to say about that….
U.S. banks have written about $400 billion in CDS contracts on European sovereign debt, according to the Bank for International Settlements. Those payouts would be triggered if Greece or Italy defaults. Because financial institutions are not required to report their CDS holdings, little is known about which banks or investment firms are on the hook, and for how much.
As I have written about previously, there is a very good chance that the world could be facing a massive derivatives crisis at some point in the next five to ten years.
If you hear the news talk about a “problem with derivatives” or a “derivatives crisis” then you will want to pay very close attention.
Over the past 30 years, the global financial system has constructed a gigantic mountain of debt, risk and leverage unlike anything the world has ever seen before.
At some point the whole thing is going to come crashing down.
When it does, it is going to affect the entire globe.
Did anyone really think that Italy would be able to get through this thing without needing a bailout? Just when you thought that things in Europe could get back to normal for a little while, here comes Italy. On Friday, there was a bit of a “mini-panic” as investors started dumping Italian financial assets. European officials are concerned that the sovereign debt crisis that has ravaged Greece, Ireland and Portugal will now put the Italian economy through the wringer. European Council President Herman Van Rompuy has called an emergency meeting for Monday morning. He is denying that the meeting is about Italy, but everyone knows that Italy is going to be discussed. European Central Bank President Jean-Claude Trichet and European Commission President Jose Manuel Barroso along with a host of other top officials will also be at this meeting. If it does turn out that Italy needs a bailout, it is going to change the entire game in Europe.
What is going on in Italy right now is potentially far more serious than what has been going on in Greece. Italy is the fourth largest economy in the European Union. If Italy requires a bailout, the rest of Europe might not be able to handle it.
This latest crisis was precipitated by a substantial sell-off of Italian financial assets on Friday. An article posted by Bloomberg described the pounding that the two largest Italian banks took….
UniCredit SpA (UCG) and Intesa Sanpaolo SpA (ISP), Italy’s biggest banks, fell to the lowest in more than two years in Milan yesterday as contagion from Europe’s debt crisis threatened to spread to the region’s third-largest economy.
UniCredit plunged 7.9 percent, the biggest decline since March 30, 2009, while Intesa dropped 4.6 percent. Both hit lows not seen since the period when markets were emerging from the crisis spawned by the collapse of Lehman Brothers Holdings Inc.
Unfortunately, this is just the continuation of a trend that has been going on for a while.
When you look at them as a group, the stocks of the five largest Italian banks have lost 27% since the beginning of 2011.
The spread of the Italian 10-year government bond yield over benchmark German Bunds hit euro lifetime highs around 2.45 percentage points on Friday, raising the Italian yield to 5.28 percent, close to the 5.5-5.7 percent area which some bankers think could start putting heavy pressure on Italy’s finances.
The Italian national debt is now up to about 120 percent of GDP. The Italian government would be able to manage it if interest rates were very, very low. But unfortunately they are rising fast and if they get too much higher they are going to become suffocating.
As I have written about previously, government debt becomes very painful once you take low interest rates out of the equation. For example, if Greece could borrow all of the money that it wanted to borrow at zero percent interest, it would not have a debt problem. But now the yield on 2 year Greek bonds is over 30 percent, and there is not a government on the face of the earth that can afford to pay interest that high for long.
If things continue to unravel in Italy, all of the credit agencies may downgrade Italy sooner rather than later.
The frightening thing about Italy is that a financial crisis has a way of exposing corruption, and there are very few countries that can match the kind of corruption that goes on in Italy.
As a child, I had the chance to live in Italy. I love Italy. The people are friendly, the weather is great, the architecture is amazing and the food is spectacular. I will always have great affection for Italy and I will always cheer for the Italian national team when the World Cup rolls around.
However, I also know that corruption is deeply ingrained into Italian culture. It is simply a way of life.
Just check out the prime minister of Italy. Silvio Berlusconi is the consummate Italian politician. He is greatly loved by many, but it would take days to detail all of the scandals that he has been linked to.
At this point, Berlusconi has become a parody of himself. Each new sex scandal or financial scandal just adds to his legend. Italy is one of the only nations in Europe where such a corrupt politician could have stayed in office for so long.
Not that the U.S. government is much better. Our government becomes more corrupt with each passing year.
But the point is that if a financial collapse happens in Italy and people start “turning over rocks” it could turn up all sorts of icky stuff.
So what is Europe going to do if Italy needs a bailout?
Well, they are probably going to have to fire up the printing presses because it would probably take a whole lot more euros than they have right now.
The truth is that the EU has now entered a permanent financial crisis. You have a whole bunch of nations that have accumulated unsustainable debts and that cannot print their own currencies. The financial system of the EU as it is currently constructed simply does not work.
Some believe that the sovereign debt crisis will eventually cause the breakup of the EU. Others believe that this crisis will cause it to be reformed and become much more integrated.
In any event, what just about everyone can agree on is that the financial problems of Europe are not going away any time soon. For now, EU officials are keeping all of the balls in the air, but if at some point the juggling act falters, the rest of the world better look out.
A financial crash in Europe would be felt in every nation on earth and it would be absolutely devastating. Let’s hope that we still have some more time before it happens.