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According to a June 28th editorial on ZeroHedge titled “The First Casualty of Brexit”:

The likely outcome is that Italy’s [prime minister] Renzi will be “forced” to take matters into his own hands and enact a unilateral sovereign rescue of the Italian banking system in defiance of the EU, unless he wins concessions soon from Brussels. Those who know him say he will not go down in flames for the sake of European ideological purity.

As a result, Brexit will be just the scapegoat used by Renzi and Italy to circumvent any specific eurozone prohibitions. And if it fails, all Renzi has to do is hint at a referendum of his own. Then watch as Merkel scrambles to allow Italy to do whatever it wants, just to avoid the humiliation of a potential “Italeave.”

Behind the Italian Collapse: Brexit or Bail-ins?

The ZeroHedge editorial questions whether Brexit was actually the cause of the Italian collapse. The banks were already in serious trouble. A good crisis was just needed so that EU rules could be suspended without admitting they were unworkable all along; and Brexit fit the bill. But the real trigger of the collapse seems to have been the bail-in scheme implemented in January 2016. According to ZeroHedge:

The new bail-in reform this year has brought matters to a head, catching EU authorities off guard. It was intended to protect taxpayers by ensuring that creditors suffered major losses first if the bank gets into trouble, but was badly designed and has led to a flight from bank shares. The Bank of Italy has called for a complete overhaul of the bail-in rules.

. . . The banking squeeze has become politically explosive in Italy after thousands of small depositors were wiped out at four regional banks late last year. They were classified as junior bondholders even though most of them were just ordinary savers who did not realize what was being done with their money.

The bail-in scheme was supposed to shift losses from governments to bank creditors and depositors, but it has served instead to scare off depositors and investors, making shaky banks even shakier. On top of that, heightened capital requirements have made it practically impossible for Italian banks to raise capital. According to Lorenzo Cordogno, former director general of the Italian Treasury, the result has been that the ECB is “unwittingly destabilizing the banks in an overzealous attempt to make Europe’s banks safer.”

Brexit, Derivatives, Meltdown, Monetary policy, fx trader, forex derivatives chart

But EU rules have been flexible in “emergencies.” Before the Eurozone debt crisis of 2011-12, the European Central Bank was forbidden to buy sovereign debt. Then Greece and other southern European countries got into serious trouble, sending bond yields (interest rates) through the roof.  But default or debt restructuring was not considered an option. The ECB finally got on the quantitative easing bandwagon and is now buying government debt along with other financial assets at the rate of €80 billion per month.

According to Evans-Pritchard, Brexit has not yet caused serious trouble in the debt markets, because this new QE policy has allowed the ECB to cap bond yields. Rather than deal with a very awkward Italeave, the EU could cave on its bail-in and bailout rules as well.

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