What happens next, now that Italy has voted ‘no’

Matteo Renzi © Getty Images
Italian PM Matteo Renzi is handing in his notice

Forget Brexit, forget Trump – the Italians have just shown us how to reject a government.

Matteo Renzi, the Italian prime minister, has lost his referendum on constitutional reform by an ego-crushingly large margin of 60% to 40%, and on a big turnout too (around 70%).

He’s following through on his decision to resign, and plans to hand in his notice to the president this afternoon.

So what happens now?

This week, it’s all about the banks

Let’s cut straight to the chase. The big issue at stake here, in the wake of Renzi’s referendum defeat, is not “Italexit” (not yet). We’ll talk about that some other time (in the next issue of MoneyWeek, in fact).

The big worry right now is the Italian banking system.

Italian banks are in a mess. They are carrying huge amounts of bad debt – far more than any other eurozone banking system. They need money. (They need to be “recapitalised”, in the jargon).

No one wants to give them that money, partly because they have too much debt in the first place, and partly because they are located inside an economy that has gone nowhere for about 20 years (which by no coincidence, is roughly the same length of time that Italy has been part of the single currency).

Now, in the grand scheme of things, the amount of money needed by Italian banks is not that great. We’re talking tens of billions rather than trillions. While that might be a lot of money to you or me, when you can print money to order, it’s a rounding error. In most countries, the government (backed by the central bank) would step in and bail them out (just as we have in the UK).

Everyone would complain about it, and you’d store up lots of unintended consequences for the future (just as we have in the UK), but the immediate problem could be solved easily.

But this isn’t “most countries”. This is the eurozone. And countries in the eurozone – as they have rapidly found out since the financial crisis – lack many options that are open to countries with their own currency.

This year, the eurozone authorities effectively made it illegal to bail out your own country’s banks. Instead, you have to force bondholders to take the losses.

That sounds like a good idea, until you get to the practicalities. In the UK, bank bonds are typically held by the big institutions. Generally, those individuals who hold them have a pretty sophisticated understanding of how they work.

But in Italy, many ordinary Italian savers have effectively been mis-sold Italian bank bonds as equivalent to a high-interest savings account. If they lose their savings, you have a riot on your hands.

The Italian government under Renzi was groping towards a solution to the banks. Either he’d have told the European authorities where to go, or they’d have come to some sort of fudged agreement. The point is, the government was working on a plan.

But now Renzi is resigning. That throws doubt on all the bailout plans and fudge and any other hopes and schemes that had been hatched up.

No surprise that Italian banks were among the biggest casualties of the vote as the markets opened this morning.

The canary in the bank vault

The biggest threat specifically is to the world’s oldest surviving bank, Monte dei Paschi di Siena. The bank was meant to be raising €5bn by the end of the year from private investors. The risk is that this result makes that harder to do.

The Italian president has 70 days in which to try to form a government. Assuming that he can do that, fresh elections aren’t required until 2018.

But there’s no doubt that this “no” vote increases political uncertainty in Italy. And do you really want to invest in a sickly bank that’s bound to become a political plaything against that sort of backdrop?

You might think not. But so far, judging by the follow-on market reaction this morning, the answer is “well, yes”. A bit like what happened after the Donald Trump victory, markets are rebounding rapidly from an initial sell-off.

There are a few reasons for this. Firstly, the “no” vote wasn’t exactly a surprise. In fact, “yes” would have been a much bigger shock. So markets were hardly unprepared for this event.

Secondly – despite its characterisation by some as being a revolt against the ruling class, the Italian “no” vote is in many ways a vote for “business as usual”, as Fathom Consulting points out. Weirdly enough, in the long run, this lack of reform makes it harder in some ways for Italy to leave the euro, because any future anti-EU government would still have to wrestle with the Italian upper house.

But most importantly, it’s all down to faith in the European Central Bank. The ECB has been hinting that it would buy Italian government bonds if things looked a bit sticky, and as is always the case when central banks promise to print money, the markets are getting excited about that. It’s a big bet on the usual dollop of “eurofudge” to smooth things over.

Are markets right to be this sanguine?

I said last week that the Italian referendum was probably a “sell the lead-up, buy the result” event. So far it looks as though that was correct.

However, just because markets can be predictable sometimes, doesn’t mean they’re right.

The banks are a gaping hole that can be plastered over, that much is true. We all know how flexible eurozone rules can be when they’re in trouble. But there’s no guarantee that we won’t have to see another big panic before it gets to that point.

Moreover, in the longer run, this “no” vote means Italy is no closer to dealing with its problems. The fundamental issue here is that the country can’t grow fast enough to resolve its debt burdens. That will now continue to eat away at social support for the status quo.

In the longer run, that can only make it more likely that a party such as the Five Star Movement gets into power. That might not lead to an Italian eurozone exit immediately – but other citizens in the eurozone might not appreciate the idea of risking their taxes being used to prop up such a vast, unhealthy economy.

My colleague Tim Price has been writing about the fragility of the Italian banking system – and its potential knock-on effect to the rest of Europe – for a good few months now. But if you want to know what the worst-case scenario could bring, I suggest you check out Tim’s views here.

  • Stephen Hulme

    Let it go to the wall. And start again.This goes for the E.U. to

    • Horiboyable .

      The whole of the west is going to the wall. The west is over, its just our timeline now.

      While China has been building power stations, airports and many cities the west has been focusing on more important pressing issues like, which bathroom transgender folks should be using or if two men should be allowed to marry. It took the UK 10 years to decide if we should have a second run way at Heathrow, while China had built 10 airports in that time. Can you see where it has all gone wrong.

      I am glad little Johnny has a safe zone at his school so he wont get called names and the school has realised that he has a lactose intolerance and how his ADD plays up when he reads too much.

      I am glad the NHS has stopped sending in staff to pubs with smoke free flyers.

  • Peter Edwards

    “The fundamental issue here is that the country can’t grow fast enough to resolve its debt burdens. That will now continue to eat away at social support for the status quo.”

    Ditto for the USA, Japan, China & the UK.

    • Horiboyable .

      Russia collapsed under communism and what we are witnessing now is the collapse of socialism. Socialism is like a Ponzi scheme, you continually need new idiots to keep the game alive. Sadly the west all have declining populations so the end is Nye.
      The state has only recently woken up to this fact and this is where the state gets desperate so expect some radical moves from the state. We have already observed this in Germany where Merkel let in over 1 million Muslims into a Christian nation. The German people are already enjoying this cultural enrichment, German women get to be raped regularly, shootings, stabbings and young boys sodomised in bathing pools because of a sexual emergency. I am sure the German people wont mind these minor sacrifices for the good of the socialist cause.
      You will soon see a slew of new taxes and restrictions on your liberty. This will be in the form of capital controls, restrictions on cash, hell they may even go the whole hog and ban cash altogether forcing you into the banking sector. You know those honest banker types, PPI, loading pensioners up with debt, we are here to save your business and right out fraud.
      Maggie Thatcher was right, the problem with socialism is eventually you run out of other peoples money. The laws of mathematics apply to everyone including the socialists

      • Peter Edwards

        Are you serious?

        First Germany has/had a declining population so Muslim refugees are a natural fit for her.

        The crimes of some refugees are always over reported by the right-wing media just like the hate filled articles when migrants from the common-wealth arrived in 50s and 60s, do you remember the enoch powell rivers of blood speech he was wrong then and the press are wrong now. They should be ashamed for demonising Muslims .

        On the topic of Socialism, Capitalism worked because it was the best way of allocating resources to the wants/needs of people in that society. You still have to practise some socialism because things like Roads, Schools, Security & Energy etc need to be planned.

        Socialism was practised by the governments that bailed out the banks this benefited the rich whom already benefited the most from globalisation as the top 1% hell the top 0.001% of the west population have taken an ever increasing amount of their respective countries GDP.
        The shrinking share of GDP for the bottom 50% means that there is not enough spending in the economies to support economic growth hence low interest rates to get this segment of the population to borrow to spend.

        Also we have a ageing population with fewer workers to support them which means either taxes go up or we borrow more, probably both. (probably reason why both main parties have let immigration flurish)

        Then we have the Bugbear of technology change that may hollow out the middle classes as their jobs are automated.

        The remedy for this situation is easy, Ban Money, Half of GDP gets shared out equally to everyone. Any jobs that need to be filled will get filled by those whom want to work. Rich countries can get rid of whole layers of business and function better.

        It may sound crazy but we only need around 10% of the population to work.

        Socialism is the end point for mature Economies not Capitalism.

        • Horiboyable .

          Nothing penetrates the collectivized mind.

          While it is true that capitalism delivers more wealth than any other economic system, I would never justify it for that reason. Capitalism is the only economic system that is compatible with individual rights. Roads and schools can all be run by the private sector. There should be total separation of the state and economics.

          All socialist regimes disintegrate into authoritarian rule. NAZI Germany is one example and a more recent example is Venezuela.

          Thank you Stalin for your response.

        • Cynic_Rick

          And Maturity, whether of the Economy, Socialism, Capitalism or anything else, precedes Death.

          It is Death that is “the end point”.