How banks go bust

I have a question for you that requires you be totally honest.

With yourself. Not with me. At stake is your understanding – and potential survival – in the next financial panic.

The question, as odd as it might sound, is this: how worried were you about whether American low-income families could pay their mortgages in 2007?

I’m going to guess that your answer is the same as most people’s which is: not at all. Unless you worked in a very specialised branch of the banking industry, or had a personal family connection to someone in the States, it’s unlikely you gave it a lot of thought.

Our brains are wired to focus more on the immediate and the local over the distant and the remote. But today I’m going to show you why that’s dangerous, particularly when it comes to panics in the financial markets.

Then I’m going to show you exactly how a crisis that currently feels distant and remote is about to become urgent and immediate at shocking speed.

A threat from the fringe

It’s publisher Nick O’Connor here by the way. Your usual editors, Nickolai Hubble and Boaz Shoshan, are off on Zero Hour Alert business (Zero House Alert is their premium advisory, in which they take the ideas you see here in Capital & Conflict a lot further and provide specific advice and solutions to go with them).

I know Nickolai is hard at work on his new book (How the Euro Dies) and his latest research report (“How Germany Betrays Europe”). So I thought I’d step into the breach for a day. I want to use this time to share some research that suggests the next financial crisis is going to come way sooner than anyone thinks.

By this October, to be exact.

That’s a big claim. But I can back it up with hard proof and evidence, if you’ll hear me out. Which brings me back to the question I started today’s letter with…

In 2007, very few people worried about the pay up rate on American low income mortgages, or subprime mortgages as they came to be known. You can see where this is going now. Those mortgages had been securitised and sold on to other financial institutions. That process also happened to mask – either deliberately or mistakenly – how risky those securities were. When they started to go bad at a much higher rate than anticipated, it created a chain reaction across the financial system that caused carnage.

By the time RBS and the rest of the banking system in the UK went to the wall, you can bet people here cared about what was going on. But by that point it was a little late. At some point, the crisis morphed from remote to immediate.

Which is another way of saying that risks develop on the fringes but can ultimately damage the centre. Therefore to predict major crises you need to understand the threat while it’s still on the margins, before it triggers a domino effect across the financial markets.

I think there’s a perfect example of this scenario staring us in the face now. It involves Italy and the technicalities of the European financial system. I think it occupies the same category today as subprime did in 2007: understood by few, but about to change the lives of many.

The next crisis: October?

That’s my claim for you today. What’s going on in Italy right now has the potential to be hugely damaging to investors everywhere, just as subprime was. Taking the time to understand the situation early is critical. It means you won’t panic down the line if we get a crash. You’ll be prepared. Calm. And that’ll lead to you making much better, less rashly emotional, decisions with your money.

So what’s actually happening in Italy?

Well, by now you’ll probably know the background: huge economy, systemically important to Europe, third highest national debt on the planet, generationally underperforming economy, huge youth unemployment.

That pressure cooker situation lead to the election of a new “populist” government in April. You could read that election as the Italian people saying, “We’ve had enough of this – let’s mix things up.”

This much you’ve probably heard before. What you need to know now is: the Italian government is about to launch an all-out challenge to the European authorities over its next budget, this October. Look at the signs and this is clear – let me lay it out for you:

  • The new Italian government is preparing to directly challenge the EU, the European Central Bank and the eurozone over its new budget this coming autumn.
  • If you look carefully, the signs are very clear:Italy is already pushing hard against the European authorities on trade, migration and spending. Italy is turning migrants away already. “I’m tired of being made fun of,” said Italian Interior Minister Matteo Salvini.
  • Not only that, the bridge collapse in Genoa recently was immediately “weaponised” as a battle over Italian spending demands and European restrictions: “If external budget constraints prevent us from spending to have safe roads and schools, then it really calls into question whether it makes sense to follow these rules. There can be no tradeoff between fiscal rules and the safety of Italians,” Salvini said.
  • This situation will come to a head over the next Italian budget, which the EU has to sign off. This will likely involve massive spending, increased pensions, universal basic income, tax cuts and a roll back of austerity.
  • This budget will back the EU into a corner and could lead to Italy getting downgraded – sending a ripple of panic across southern Europe.

That’s how Nickolai and I laid it out in our urgent warning to investors last week. If you haven’t watched it yet I recommend doing so now.

We’ve actually already been proved correct. One rating agency downgraded Italy over the weekend.

Banking contagion?

What’s more worrying to me is this. The situation with the Italian government’s spending and deficit plans is coming to a head. There’s every chance it’ll kick off round ten of the euro crisis, leading to a spike in borrowing costs for southern Europe.

In fact, Italian ten-year bond yields have doubled in the last year already. If bonds are unfamiliar to you, a spike in the yield means the price of the bond is falling. If you hold bonds and yields go through the roof, you’re likely losing money. Potentially a lot of it.

Which is which it’s worrying that Italian banks are doubling down on their purchases of Italian government bonds. Italian banks hold €350 billion worth already – and rising. Meanwhile, foreign agents are selling and getting the hell out of the Italian bond market.

Why might that happen? I see two options. Either the Italian banks are acting monumentally stupidly – sinking cash into debt that could go bad due to the political situation this autumn. Decisions like that are how banks go bust. That could turn a sovereign debt crisis into a wider banking crisis – which would be much harder to contain.

The second option is the Italian banks want to tie their fate to the Italian government’s. Perhaps the banks know something we don’t. In the event Italy decides to leave the euro – or launch a rival currency and convert some debt obligations into that – perhaps it makes sense to be “in” with the government.

Perhaps. It’s hard to know exactly. But what’s clear to me is the situation is getting more serious by the day. Data this week suggests the Italian economy is falling into recession, which won’t help things one bit. It’ll put even more strain on Italian public finances, at exactly the wrong moment.

If I’m not being blunt enough: I’m telling you it’s critical you understand what’s happening now, before things get any worse. This situation could blow up in October.

The question you have to ask yourself is: are you prepared for that… or will you be taken by surprise?

You may not agree with everything I’ve said today. But I hope I’ve given you cause to at least give this further thought. Dedicate some time to it. Think things through carefully. It could be the most valuable thing you do all year.

The full threat is laid out for you in this urgent broadcast.


Nick O’Connor
Publisher, Southbank Investment Research

Category: The End of Europe

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