The Phaserl


The Fix Is Already In, as Italy’s Moment of Truth Beckons

by Wolf Richter, Wolf Street:

Banks cannot be allowed, at any cost, to suffer the consequences of their own mismanagement, or worse.

Italy holds a constitutional referendum on Sunday. Europe is sick and tired of national referendums, in the opinion of Jean Claude Juncker, the president of the European Commission. Over the past week, Juncker has urged EU leaders not to hold more referendums as he fears that other European electorates may take a leaf out of the UK’s book and vote to leave:

“Regarding referenda on EU membership, I think it is not wise to organize this kind of debate, not only because I might be concerned about the final result but because this will pile more controversy onto the huge number already present at the heart of the EU.”

It’s not hard to understand Juncker’s distaste for referenda: the EU has been on the losing end of just about every popular vote of this fledgling century. Whenever people in Europe have been given the rare opportunity to vote on Brussels-related business, they invariably vote against Brussels. In fact, the only vote the EU has won this century was in Ireland in 2009, and that was only after the people had first voted against the Treaty of Lisbon. It was the wrong answer and voters were politely invited to reconsider. Or else.

Next up for the EU establishment is Italy’s constitutional referendum on Sunday. The vote on the Renzi government’s proposed constitutional reforms would, in normal circumstances, be a virtual non-event beyond Italian borders, if it weren’t for two key factors:

Italian premier Matteo Renzi’s pledge, repeated multiple times (albeit, ironically, not so much recently), that he would resign if the constitutional reforms are not passed. Renzi’s resignation threat was gingerly confirmed on Friday by Italy’s Transport Minister Graziano Delrio.
Italy’s blossoming banking crisis, which poses an existential threat to Europe’s closely integrated, highly vulnerable, contagion-prone financial system.

It is the banking crisis that has Brussels most worried. As Italy’s finance minister Pier Carlo Padoan admitted on Thursday, if the vote goes against Renzi, the resultant political uncertainty would make it even more difficult to raise capital, putting at risk as many as eight mid-sized financial institutions, all of which are already at or beyond the brink of solvency.

They include Monte dei Paschi di Siena, home to an estimated 35% of Italy’s €360 billion of non-performing loans. The bank, whose shares are now worth less than €0.20, has failed spectacularly to come up with a convincing plan to steady its finances, despite all the creative assistance it’s received from Wall Street’s biggest bank, JP Morgan Chase, and Italy’s most influential investment bank Mediobanca.

MPS has managed to persuade bondholders to swap their holdings for shares, at roughly 20 cents on the euro. But the second part of the rescue plan involves issuing new shares worth almost 10 times its current market cap. An ‘anchor investor’ (such as Qatar’s sovereign wealth fund) taking a large bloc would be the ideal solution, since most smaller investors have already been burnt in two previous capital expansions.

But even big-time investors with more money than sense, or hoping to call in big favors at a later stage, will be hard to find if the referendum leaves the country without a government. In such an event, a caretaker government would have little choice but to carry out a highly sensitive ‘bail-in’ of junior bondholders, including many small-scale retail investors who were criminally “missold” complex financial instruments during the liquidity-starved days of Italy’s sovereign debt crisis. In the worst case scenario, a bail-in of MPS could become the catalyst of a system-wide bank run.

To avoid that outcome, every effort will be made to keep MPS from crumbling under the weight of its own toxic debt load, even if that means bending or breaking the rules of Europe’s sacred bail-in legislation before they’ve been put into use. As Italian daily Corriere della Sera reported on Friday, Italy is in last-gasp negotiations with the European Commission over the terms of a state bailout of MPS. The taxpayer funded-rescue has already been requested and could be launched as early as next week, “if needed” (ha!).

It would just mean having to apply the rules “with greater flexibility,” sources told Reuters. It’s a beautiful way of saying “break the iron-clad rules we ourselves created to prevent such a possibility.”

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