Greece was one thing; Italy may be too big for the EU to save

Over the past decade or so we’ve become used to Italy being in meltdown – now it is in lockdown, too. Together, these evil twins, represent a threat of potentially enormous consequence – for Italy, for Europe and for the world.

The immediate news is that the Italian government has made the bold decision to suspend mortgage repayments because of the coronavirus outbreak. Italy’s banking industry group, ABI, which represents some 90 per cent of total banking assets, said that it members would offer debt moratoriums to small firms and households struggling with the fallout of the virus.

And what a fallout it is. All public gatherings cancelled, universities and schools are closed until next month. Everyone in Italy confined to the area where they live, unless they are able to demonstrate a need to travel elsewhere. The head of Italy’s Democratic Party, Nicola Zingaretti, has tested positive for Covid-19. With over 10,000 infections and 631 deaths (at the time of writing), Italy currently has the world’s second-largest number of coronavirus infections after China, and by far the largest in the west. Prime Minister Giuseppe Conte has promised “massive shock therapy” to bring the economy back to life. He may be overdoing it.

Two facts need to be focused upon. One is that Italy has the highest incidence of Covid-19 in Europe; the other is that it has the weakest banks.

The question, then, is a simple one. Can the damage now being wreaked on Italy’s real economy – shops, offices, factories, restaurants, football stadia – be sustained by her banks and state? How will Italy pay for an indefinite moratorium on household and/or business mortgage debt?

We cannot answer these questions for sure, because we cannot know how long the crisis will last, how severe it will prove. But if the past few years are anything to go by, the precarity of Italy’s national finances – a high absolute level of national debt at 135 per cent of GDP – means it has little scope to support the banks, which are notoriously exposed to bad debts and insecure assets (ie Italian government bonds).

If the Italian banks decide to cut back borrowing because the national authorities cannot realistically carry every household and company, then the real economy will pushed into a further slide, Italy’s already stagnant economy into recession. The negative feedback effects between the state, the banks and real economy will create a tailspin whose ultimate result will be the bankruptcy of the Italian nation. Coronavirus contagion will induce a financial contagion, one that similarly refuses to respect national borders.

Things might not be so bad – Italy (like Britain in the more distant past) has had to rescue by international lenders such as the International Monetary Fund (IMF). But nowadays, Italy’s crisis is primarily Europe’s; when Italy catches a cold, Europe will catch pneumonia. The euro cannot permit a major economy (Italy is the Eurozone’s third-largest) to collapse in a disorderly mess. That means the European Union, European Central Bank (ECB) and, in effect, the taxpayers of Germany, the Netherlands and the few other solvent countries of the EU. Basically they will be asked to pay Italians’ mortgages for a year or so. That’ll not go down well with their voters.

The political flesh may be willing; but the spirit may be weak. During successive euro crises after 2009, the Germans did indeed support Italy, as well as others such as Portugal, Ireland and Cyprus. The question now is not whether the EU (read: Germany) is willing, albeit grudgingly, to rescue Italy, but whether Italy could overwhelm even Germany’s resources. Rescuing Greece back in 2010 or so was one thing – Italy, on the other hand, may be “too big to fail”, and to save.