The Phaserl


The Impossible Italian Job

by Don Quijones, Wolf Street:

The Italian Banking Crisis would complete Europe’s “Doom Loop.”

Italy’s repeated attempts to stave off a full-blown financial crisis and breathe life back into its moribund banking sector can be summed up in four words: too little, too late.

In April, it set up a bad bank vehicle called Atlante that was expected to bail out the country’s most troubled lenders as well as allay growing fears of a systemic crisis within the financial sector. With just €5 billion of funds to its name, it did neither.

Cue Plan B, which saw the EU in June grant permission for Italy to use “government guarantees” to create a “precautionary liquidity support program for their banks“ worth €150 billion. On the surface it seemed like a lot more money, but in the end it amounted to little more than a PR stunt. The stampede out of Italian banks barely missed a beat [As Fears of “Bank Run” Escalate, Italian Banks Get €150 Billion Bailout of Empty Promises].

Finally, at the end of July things got seriously serious with the unveiling of Plan C: a third, much larger rescue deal for Italy’s chronically dependent and third largest bank, Monte dei Paschi. The deal involves a consortium of banks, led by JP Morgan, and in a secondary role, Italian investment bank Mediobanca, which will apparently help Monte dei Paschi raise €5 billion in new capital and sell €9.2 billion in bad loans at a deep discount to get them off its books.

As we reported, the underwriting fees are going to be extraordinarily juicy, in particular for JP Morgan. For Monte dei Paschi, meanwhile, the impact could be somewhat more muted, especially given the immense difficulties it’s likely to face offloading close to €10 billion worth of putrefying debt that nobody wants to touch, as The Economist points out:

As the Distressed-debt investors tend to buy loans in bulk, and hence prefer loans with easily recoverable, tangible collateral. The NPLs of stricken British, Irish and Spanish banks in recent years were largely mortgages: being backed by property, they could be valued from current real-estate prices. British and Irish courts are also pretty efficient at dealing with claims on collateral. Many Italian NPLs, by contrast, are uncollateralised loans to small businesses or consumers. Even when collateral has been pledged, Italian courts are much slower than those elsewhere to recover it.

This may help explain why since the announcement of its latest “rescue” on August 5, MPS’ stock – reduced to a penny stock long ago – has plunged a further 8%, from €0.25 to €0.23.

If investors do not believe that even JP Morgan Chase, with the help of an all-star cast of global systemically important, precariously interconnected financial institutions, can sanitize a fraction of the bad debt putrefying on the balance sheets of the country’s third biggest bank, then Italy — and by extension, the Eurozone — may have even bigger problems than previously thought. After all, Italy accounts for roughly one third of the Eurozone’s estimated €1 trillion worth of non-performing loans.

But that hasn’t stopped its banks from continuing to extend dirt-cheap credit to loss-making companies. Perpetual loss-makers such as fashion retailer Benetton and Feltrinelli, one of the country’s largest booksellers, continue to receive ridiculously low-interest loans — all made possible, of course, by the liquidity glut conjured into existence by ECB Chairman Mario Draghi’s negative interest rate policy (NIRP).

As happened in Japan at the beginning of its so-called lost decade, which to all intents and purposes continues to this day almost 30 years later, instead of biting the bullet and booking losses, large banks in Italy have kept credit lines open to borrowers even when it was clear they had no chance of honoring their obligations.

Where Italy differs from Japan is that it is already well into its second lost decade and the sheer scale of its problems are only just beginning to emerge, having been masterfully masked by an epic expansion of bad debt, which jumped from 5% of banking assets in 2008 (5% being the threshold for sound banking) to almost 20% today.

Yet despite — or perhaps because of — the unconditional generosity of Italian banks to Italian firms, the country’s economy continues to stutter. It is smaller today than it was in 2008 and not much larger than in 2000. And according to Enrico Colombatto, a professor of economics at Turin University, the future holds even grimmer prospects:

Growth continues to disappoint and the estimates for 2017 have recently been cut, unemployment is relatively high, investment is stagnant and companies keep going belly up. Furthermore, Italian treasury bonds would be worth much less than their present price if the markets did not believe that, should the need arise, the European Central Bank would step in and bail out the Italian government.

That is precisely what the ECB and the European Commission will end up doing. The alternative is beyond unthinkable: Not only would it mean allowing bank bondholders — including very large foreign banks and hundreds of thousands of Italy small savers — to take a massive hit, potentially sparking a run on bank deposits; it would also trigger the final dreaded phase of Europe’s so-called doom loop.

If Italian banks began falling like flies, it would only be a matter of time before investors began selling (or shorting) Italian bonds en masse, by which point the Doom Loop would be in full flow. The more the bond prices fell, the more impaired the banks’ balance sheets would become since they hold a big chunk of these bonds. And it would speed up the stampede out of Italian bonds and banking shares. Rinse and repeat, until all that’s left is a smoldering husk of a banking system.

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