QUESTION: Mr. Armstrong, why are Italian banks in worse shape than most other countries. What happened to the bail-in program of the ECB? Can you explain why Italy is threatening the entire banking system of Europe?
ANSWER: The bail-in policy of the IMF and ECB was directed at the idea that the rich would pay, even if that meant paying for pension funds. But in Italy, stock ownership is distributed predominantly among individuals. Therefore, politicians were unwilling to deal with the crisis. Forcing bank holders of shares and bonds to take a haircut meant the middle class would be scalped, and that meant political unrest. Italy never cleaned up its banks, and as such, it has been a growing problem with about €360 billion in underperforming loans. This is nearly 18% of all loans in Italy. They are dealing with this in the typical manner of forcing haircuts on those who have been stupid enough to invest in banks in other countries that amazingly go back for more pain and suffering. In Italy, this may lead to a pitchfork revolution.
This is not unusual. This was also the core crisis that created the Great Depression. In that case, foreign governments issued bonds in dollars in small denominations and the New York bankers sold them to the general public. The crisis emerged because this was a Sovereign Debt Crisis in 1931. Hence, there could be no bailout domestically within the United States to protect foreign bonds sold to domestic mom and pops.
As the economic depression deepened in the United States during the early 30s, which also was when the Dust Bowl unfolded, farmers had less and less money to spend in town and could not pay their loans. Banks began to fail at alarming rates in the Mid-West as farmers could not repay, and in the East, the default on foreign government bonds wiped out savings and caused depositors to withdraw funds. During the 20s, there was an average of 70 banks failing each year nationally. During the first 10 months of 1930, 744 banks failed. By 1934, 9,000 banks had failed in all. It’s estimated that 4,000 banks failed during the year of 1933 alone. By 1933, depositors saw $140 billion disappear through bank failures.
This is what made the Great Depression so great. Banks saw bad loans soar and mom and pops who bought foreign bonds were wiped out. The combination of these events led to the massive collapse in the capitalization of the economy. More than 200 cities had to issue their own money for there was a shortage of money and banks.
When mom and pops hold the bonds and shares of the banks, the option of a haircut is greatly diminished. The risk that we now see in Europe is the further deflationary pressure of the collapse of capitalization of the European financial system. This is not something that can be resolved by the ECB. When a country surrenders its currency, it is indistinguishable from a gold standard if they lose the ability to devalue to offset the crisis. The pressure would normally have been offset by the collapse of the Italian lira. That being extinct, the pressure becomes a contagion that will spread throughout Europe.
This is the price of a single currency, but without full federalization politically. This combination of events renders the crisis insurmountable and the outcome can only be the destruction of the euro and the single monetary system. The danger here is that the politicians in Brussels will fight to save their personal power at the expense of the entire continent.