08 Jul 2016 17:09 IST

Is there another global financial meltdown in the making?

Developments in the UK and Italy could trigger a crisis

Even as the holy month of Ramzan, which saw some gruesome violence across the world, comes to an end, other worrisome trends are becoming evident in the financial world.

The realty fear

One has to do with the UK, and predictably, is related to the Brexit.

Ever since the vote, investors have rushed to take out their money from property funds, fearing — and rightly so — that the real estate in the country will suffer due to the exit. As a result, seven investment firms have suspended trading in their property funds, freezing about $15 billion in assets — that is more than half of the $24 billion invested in UK’s open-ended real estate funds.

What is it?

A fund is open-ended when it invests using the cash that investors have put in. A closed-ended fund is traded on an exchange and investors are issued shares. In an open-ended fund, investors can draw out their money whenever they want to. But now, investors in these seven UK property funds will be unable to do so.

UK, especially London, is one of the favourite real estate markets for global investors. But many of them now think the value will drop — by as much as 20 per cent, according to some estimates — as the country exits the European Union.

This brings back the nightmare of 2007 credit crisis, which was set off after two property funds, belonging to Bear Stearns, were clamped shut. There are fears that the present bearish sentiments could lead to a similar upheaval in the financial world, especially if the UK banks have a high exposure in the real estate sector.

The Italian crisis

The second disturbing trend comes from across the English Channel, from Italy.

From Thursday morning, investors have been barred from short selling shares in Italian bank Monte dei Paschi di Siena for three months. It is the world’s oldest bank, set up in 1472 (even before Genghis Khan came to India or the Mughal Empire was formed). But now, the institution is way past its glorious days. A story in Business Insider says the bank’s shares have fallen by more than 99 per cent since the 2008 financial crisis.

The trouble in the bank is reflective of the country’s deep financial crisis. Collectively, banks in Italy are under $400 billion of loans and the public debt is 135 per cent of the GDP.

Efforts to clean the banks have been slow and lackadaisical, mainly because of a sensitive, political issue. As the Economist article says, much of the bank bonds are in the hands of retail investors, and any effort to clean the system will hurt the common man. In most other countries, bank bonds are held by institutional investors who are big enough to handle some of the losses.

Is it doomsday?

So is it all doom for Europe, and the global financial markets?

Well, there is still some hope left. In the UK, banks’ exposure to the real estate sector has come down from what it was in 2008. This will help contain losses in the case of a meltdown in the real estate sector.

And in Italy, the government is exploring new ways to infuse money into Monte dei Paschi, which will bring relief to the financial system and give the government some more time.

But the real question is if there is enough political willpower to clean the books. That could hold the key to financial stability.