What is currently happening in Italy is the scariest thing I have seen in the Eurozone since the third bailout package of Greece in 2015. /1
The European banking union cannot handle the consequences of a full-scale Italian financial disaster. /2
There is still also no adequate sovereign debt restructuring mechanism in case Italian debt would rise to unsustainable levels (due to a collapse of GDP and rising interest rates). /3
The doomloop between Italian banks and the government has not been broken. So expect capital outflows from wealthy Italians, rising bank spreads and larger funding problems for Italian banks (watch Target 2). /4
Italy is too big to fail - without Italy no Euro - and presumably too big to save. Eurozone rescue funds could prove to be insufficient in size and mobilizing the rescue funds might be politically infeasible due to resistance from the Northern European countries. /5
The lender-of-last-resort functions of the ECB (OMT) will only apply if Italy voluntarily subjects itself to a rescue package from the Troika, which will likely include fiscal austerity and structural reforms. /6
If there is full-blown panic on Italian bond markets, and Italy does not want to subject itself to a Troika program, the ECB will not backstop the Italian bond market, and a self-fulfilling sovereign debt crisis will emerge. /7
Banking union requires bail-in of creditors in case of saving systemically important banks. In Italy, this has proven to be extremely difficult politically. It is not clear whether European bank resolution functions can apply if Italians refuse bail-in. /8
Italian politicians will determine whether the ECB will be able to backstop the bond market, whether banking union can ensure stability of the financial system and whether sovereign debt remains sustainable. /9
If Italy's political and financial system go into chaos, and neither lender-of-last resort, nor debt restructuring nor European rescues are feasible, then the only outcome can be that Italy breaks out of the Euro and this could threaten the survival of the entire Eurozone. /10
