As Italy Enters Its Fourth Recession Since 2000, Who Will Bail Out Unicredit?

Italy, which is still the eurozone's third biggest economy, slipped into a recession in the third quarter. The Italian economy fell into what is now its fourth recession in less than a decade as gross domestic product shrank 0.5 percent from its level in the second quarter, when it contracted a revised 0.4 percent, the national statistics office said today. This is already Italy's worst recession since 1992, and there is evidently more and worse to come.

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Italy effectively followed Germany, Europe's largest economy, in posting two consecutive quarters of contraction -- the technical definition of a recession. Spain contracted on the quarter, while France narrowly avoided recession by posting a slender 0.1% expansion after contracting in the second quarter.

From the third quarter of 2007 the economy contracted 0.9 percent, and this was the sharpest year on year quarterly decline in more than 15 years. ISTAT will provide a detailed breakdown of the GDP figures when it releases its final report on Dec. 12.

Europe's fourth-biggest economy will shrink 0.1 percent this year and 0.2 percent next year, the IMF said separately today, while Italy's employers organisation Confindustria are forecasting a 0.2 percent contraction this year. Making a rough, back of the envelope, calculation, if the economy once more contracts by 0.5 percent in the last quarter, we could be looking at a 0.4 percent contraction this year over 2007, and a year on year drop of around 0.9% again in the last quarter.

The real problem being raised here is not so much the recession itself, but the long term trend growth of the Italian economy in the light of the need to sustain a sovereign debt in the region of 104% of GDP and financing a rapidly ageing population. As can be seen in the long term growth chart below, Italy's growth rate has been steadily dwindling for some time now, and it is clear that this tendency is not going to be reversed any time in the near future.

Just how delicate all of this now is is highlighted by Italy's programme to help the banking system cope with the consequences of the global financial crisis, and deal with the impact of the economic unwinding which is currently taking place in Eastern Europe, which was finally approved by the European Commission earlier today (Friday).

The Commission said in a statement that the plan to offer guarantees for new banking debt and other aid was needed to remedy serious disturbances in the Italian economy.

"The Italian guarantee and swap scheme is an effective instrument for boosting market confidence and the commitments we have secured from the Italian authorities ensure that distortions of competition are kept to a minimum," EU Competition Commissioner Neelie Kroes said in a statement.

The Italian government says its conservative banking system has been hit less hard than others by the crsis, but even so the government has offered to swap up to 10 billion euros ($12.5 billion) in government bonds in temporary exchange for other forms of debt held by banks.

This sum compares with the Austrian government's 100 billion euro ($129 billion) banking package. Despite being a small country, Austria has a fairly large exposure to the East European banking system (equivalent on some estimates to 100% of Austrian GDP), but the exposure of Italian banks (and in particular Unicredit (UNCFF.PK)) is hardly negligible.

In reality, most of the capital that is being "readied up" is destined for use in underpining lending in CEE countries including Romania, Hungary, Bulgaria, Poland and the Baltics. As the Eastern Euopean euro-pegs break or the currencies slide, domestic households will have to be "eased of" CHF and euro denominated loans, and the subsidiaries of Austrian, Belgian, Swedish and Italian banks look set to have to eat large loses as a consequence.

"That this is about providing credit to Austrian companies is just a pretense," said Matthias Siller, who manages emerging market funds at Baring Asset Management. "This move is a clear commitment to eastern Europe......But this has nothing to do with charity. Those (Austrian) banks are system-relevant banks in central and Eastern Europe, and if they had to withdraw capital from there, this would set off a landslide," he said.

By tapping their home governments, the banks with CEE exposure effectively lean on taxpayers in their home countries for refinancing countries with large current account imbalances, and large forex household debts. In other words Italian taxpayers are going to have to fund the losses of Unicredit and other banks on their CEE lending just as the US Treasury is having to fund United States sub-prime loses, but the difficulty is that Italian taxpayers are already "in hock" up to their eyeballs, and if people aren't careful Italians could end up paying for some of the CEE loses with part of their future pension entitlements.

This is why this is no simple and ordinary "technical recession" and why the issue of where the money is going to come from to refloat Unicredit should the worst come to the worst, is the number one question facing the European bank bail out at this point.

Comments

[dr.doolittle:]

wow. An Austrian bank collapsed in because it got caught up in some bizarre commodity trading scheme. Do you remember that story? What was the bank? I thought it was some electrical engineering bank or something like that? Most historians argue that the Great Depression began with the collapse of the Austrian bank CreditAnstallt (spelling?) Do you know any of this history? Are we looking at something similar now? And how does Italy have a sovreign debt default when it is part of the Euro currency? By definition it can't--it would be more like the State of NY defaulting, and therefore the public sector would collapse. What are the social ramifications of such a thing? How about military spending, too? My God, the ramifications truly are staggering.

2008 Nov 15 11:42 AM

[swaps:]

I agree that the current financial crisis is potentially more serious because it is so widespread. But I think the naked short sellers are ruthlessly driving down stock prices farther than they would otherwise go, and this is leveraging the downturn as well.


I fail to see how the close linkages that come with globalism are really great for the New World Order because we now have everything more in lockstep and there is no fluctuating equilibrium from more random separate parts.

Clearly, the highest elites have been displaying the most panic, and this panic is becoming more self fulfilling as industries that might just slow are starting to brake more rapidly from fear.


But I recently used this panic to buy some Enlay.pk, the Italian electric utility I made money with and sold last year. But I bought it at 7 and now it is like 6.4 but I am still getting a 19 percent dividend yield, for now, from my purchase price.

It is interesting that the prior post points out the Austrian dominoe effect that is suspected as the first falling dominoe that led to the depression. And now small Austria has a far higher negative influence again, compared to the larger Italy.

This is all so strange. Is this financial crisis an accident, an unintended consequence, or a carefully thought out conspiracy to create a crisis that requires a more integrated global solution?

Dan

2008 Nov 15 07:03 PM