Early this year, I was worried about Glencore, the U.K.-based commodities giant, posing a global financial threat. Fortunately, they sold enough assets quickly to avoid that fate. Now, I’m worried about the Italian banks. The combination of under-capitalized banks with as much as 15 percent non-performing loans in a nation with no productivity growth, an aging population, and lavish entitlements . . . . . what could go wrong?
What could go wrong are the credit default swaps, sold to protect bondholders against losses in bonds issued by the Italian banks. Nobody knows who is “holding the bag” and must absorb those losses. Therefore, nobody knows which of these derivatives may “blow-up.”
Analysts point out that direct U.S. exposure to Italian banks is only 0.4 percent of bank assets, but that reminds me of Ben Bernanke saying subprime mortgages only represented 1 percent of all mortgages in this country and look what happened.
The next pivotal date is July 29th, when European authorities will release results from a stress test of their banks. If it calls for a major re-capitalization, the stock market will over-react. If it does not, I will be even more worried.