Even supposedly good debt on banks’ books may end up putrefying.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
This week the world’s oldest surviving bank, Monte dei Paschi di Siena, tried to give itself a new lease of life by bringing in fresh blood at the top, following revelations that the Italian lender’s chief executive, Fabrizio Viola, and former chairman, Alessandro Profumo, are under investigation for alleged false accounting and market manipulation.
But the change of guard did nothing to improve market sentiment or performance. By Friday MPS shares had sunk to their lowest point ever — just 21 precarious cents above zero — and, once again, they had to be halted by Italy’s FTSE MIB.
MPS’s new boss Mario Morelli (formerly of Bank of America-Merryl Lynch, Unicredit and Intesa), faces an insurmountable challenge trying to steady the leaking ship. MPS must raise up to €5 billion as part of an emergency rescue plan to stave off the risk of being bailed in, and consequently wound down or chopped up into little pieces and gobbled up by its rivals.
Given that it would be the bank’s third cash call in as many years, investors are understandably reticent to pour yet more funds into the bottomless pit, Reuters reports:
(The bank’s) 45-billion-euro mountain of bad loans is deterring investors from backing it in its third recapitalization in as many years, according to four leading European fund managers and the investment banking source with knowledge of the matter.
Since the private sector-backed rescue blueprint was announced in late July, hundreds of investors had been sounded out about buying stock but interest has been lukewarm, said the source.
This could be bad news, given that for MPS’ latest rescue plan to have any chance of working, both parts of the plan — Part A and Part B — must succeed.
Part A consists of a €28 billion bad-loan sale for which JP Morgan Chase, Citi and Italian investment bank Mediobanca are already assembling a bridge loan, in return for very handsome fees. Atlante, Italy’s deeply opaque, Luxembourg-based bank rescue fund, has reportedly agreed to buy the so-called mezzanine tranche in Monte dei Paschi’s bad loan securitization.
Apparently demand for heavily discounted, slowly-decomposing bank debt in Italy is high, which is great news considering Italy is purportedly home to roughly a third of all of the bad debt at EU banks. In a perfect sign of our yield-starved times, last week saw around 250 global investors converge on Venice to attend Banca Ifi s SpA’s “Non-performing Loan” conference. That’s twice as many as last year, reports Bloomberg.
In other words, Part A of the rescue plan seems to be coming along nicely — as long as no one asks who will make up the difference between the book value of the bank’s toxic assets and the discount value at which they’re now being sold.
As for Part B of the Plan — MPS’ €5 billion cash call scheduled for the end of this year — it’s going nowhere fast. Twice-bitten, thrice-shy investors are no longer buying the hype. Gennaro Pucci, chief investment officer at London-based investor PVE Capital, said that even if a significant proportion of MPS’ bad loans were “spun off into a special vehicle,” he would not buy more MPS shares out of fear that the bank could suffer further losses from the remaining soured debt.
This is a serious problem in today’s Italy: as long as the economy continues to stagnate, much of the supposedly good debt currently on the banks’ books will also, sooner or later, end up putrefying. It’s already happened to Banca Popolare di Vicenza, a regional lender that was rescued from bankruptcy late last year by the Atlante fund, but which is already in need of fresh funds.
So, too, is Italy’s biggest and only global systemically important financial institution, Unicredit, which has a staggering €80 billion in bad debt on its balance sheets — more than any other European bank. While the downfall of MPS would be enough to cause serious damage to Italy’s already fragile financial system, the collapse of Unicredit, which has vast, sprawling operations across Germany and Eastern Europe, would threaten the stability of the entire Eurozone.
Hence, Unicredit’s frantic efforts to clean up its books. According to The Wall Street Journal, in the coming months Italy’s largest bank plans to fatten its capital cushion by at least €8 billion. It’s also contemplating unloading, in one fell swoop, as much as €20 billion of its bad loans.
But with so much bad debt being offloaded at the same time, who’s going to buy it all? Top candidates: the Italian government and/or the ECB. But that is currently out of the question.
New EU regulations make it almost impossible for Eurozone governments to bail out domestic banks — at least not until the banks’ creditors, including uninsured depositors (those with over €100,000 in their accounts) and bondholders, have been forced to bear some of the burden, as should happen in any business restructuring or bankruptcy.
The problem here is that as much as 40% of Italy’s bank bonds are held by retail investors — many of whom are traditional voters of the governing political party. There’s also the risk that a bail-in of one institution could very quickly evolve into a bank-run on all of them. And that would not only spell the end of Prime Minister Matteo Renzi’s term in office; it would cement the rise of the anti-austerity, anti-euro Five Star Movement.
In the face of such risks and constraints, Italy faces an impossible mission in trying to stabilize its financial sector. With anti-European sentiment on the rise in Germany and the nationalist Alternative for Germany party breathing down her neck, Merkel is determined not to give an inch on the issue of an Italian bailout — at least not until after Germany’s federal elections, scheduled for October next year. Judging by the current state of play, that will almost certainly be too late.
In fact, the only thing that might save Italian banks from their current predicament is if Germany’s own too-big-to-fail monstrosity, Deutsche Bank, were to be bailed out first. The way things currently stand, that’s not out of the question. By Don Quijones, Raging Bull-Shit.
Things could get very ugly, very fast, if those bank bonds collapse. Read… Goldman Sachs Just Launched Project Fear in Italy
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I have to give credit to Mr Q for his choice of words: “Deeply opaque” is a very apt definition for Atlante, the shady Italian rescue fund.
According to the fund’s own press release it was “created by a private society, Quaestio SGR” but “its creation was promoted by the Italian government”. Given the track record of such enterprises worldwide one may be excused for having to repress the word “cronyism”.
There’s also the question of why, if Atlante was “promoted by the Italian government” with taylor-made rules, the fund is Luxembourg-based.
Finally there’s the issue of funding. While it has been often said Atlante would “soon” have access to over €5 billion in funding, the situation is nowhere near as rosy.
Unicredit and Intesa San Paolo both pledged €500 million. Cassa Depositi e Prestiti (CDP for short), another opaque (but wholly State-owned) financial institution, pledged another €500 million. Finally a gaggle of minor banks pledged a further €500 million. This means that if everybody has already paid the money pledged Atlante only has €2 billion available of which about one is already earmarked for the “recapitalization” (read: bailout) of Popolare di Vicenza.
How Atlante expects to more than double the funds available, and fast, remains part of the mystery.
But the mystery deepens.
There’s a second Atlante fund, imaginatively called Atlante 2 (A2 henceforth to avoid confusion), whose sole purpose is to buy bad debt from MPS and Veneto Banca.
It’s this A2 fund which is supposed to drive up demand for bad debt in Italy. But things get truly truly interesting when one sees how this fund is supposed to be funded.
So far it has gathered €1.75 billion and a breakdown of the main investors makes for very interesting read: Unicredit and Intesa San Paolo contributed €150 million each. Insurance company Generali contributed a further €200 million. But, here’s the juicy bit, the Italian government has so far been the most enthusiastic investor: it contributed €200 million through the Posts, €250 million through the aforementioned CDP and a massive €450 million through SGA, another wholly State-owned institution. This means out of the €1750 million A2 has so far gathered, €900 originate from the “usual suspects” (read: taxpayers).
One can be forgiven for thinking the Italian government is bailing out these banks in not very subtle faction, but the EU has already ruled this transfer of public funds does not constitute State aids. I am sure Apple’s lawyers are taking notice of this as their customer was blasted for being far less brazen.
One problem that needs to be understood is the only reason Italy has a stagnant (or to be more precise, slowly contracting) economy and is not spiralling into a long-delayed recession is asset inflation, in the specific housing.
Italy has desperate need of old fashioned liquidation in the housing market but this is not allowed to happen. A good part of the reason is the collaterals propping up that mountain of rapidly decomposing debt are overwhelmingly composed of housing: should prices readjust, collateral value would plummet overnight and then MPS would look like a well capitalized, solid bank.
To this it must be added there’s widespread suspicion about collateral quality. It’s one thing to post as collateral a newly renovated flat in the most fashionable part of Milan and quite another to post an abandoned furniture factory. Banks have routinely been caught magically transforming low value, low quality collaterals into high quality ones. So far nothing more than fines have been slapped, fines the banks did not resist, hinting they don’t want to draw too much attention. Should the practice be found to be not merely widespread but commonplace…
Really appreciated your elaboration on the meaning of opaque. It greatly added to an already interesting article.
Chapeau.
Excellent follow-up. Thank you.
Great explanation. Thanks.
Here’s my caboose to the congratulations train, I’m very grateful for all this clarity. Don Quijones is no journalist, he’s valuable!
Great quote: “Apparently demand for heavily discounted, slowly-decomposing bank debt in Italy is high, …”
In the Ag business manure has value as fertilizer to be tilled into the soil after harvest as it does contain nitrogen, phosphorus and potassium. I did not know that there was a market for buckets of shi# from Italian banks though!
Problem is .. those Italian bank ‘buckets of shi#’ are waaaaaay lacking in micro nutrients ….. to be of any value ! ;’)
Too much NPK (unrestrained credit) will ultimately burn-out, and kill the host planet …er …I mean plant ….
The bankruptcy of CreditAnstalt in Austria (1931) was the proximate cause of the collapse of the house of cards that was international finance built in the 1920s, which triggered the “Great Depression” (and WWII).
The bankruptcy of Lehman Brothers (2008) was the proximate cause of the collapse of the house of cards that was international finance in 2008, which triggered the “Great Recession.”
Will the bankruptcy of Monte dei Paschi di Siena be the proximate cause of the collapse of the current financial “house of cards” precipitating another “Great Depression,” (or possibly revolution)?
As Einstein is said to have observed “insanity is repeating the same actions and expecting a different outcome.” What will it take for the human race (or its “leadership”) to learn to avoid these repeated economic implosions, collapses, and fiascoes.
” What will it take for the human race (or its “leadership”) to learn to avoid these repeated economic implosions, collapses, and fiascoes”
Short answer: It will take the complete dismantling of the social construct whereby some (human) “leader” whether democratically elected, royally inherited, by decree or otherwise, makes decisions on behalf of the rest of the plebiscites.
Long answer: Human nature being such that self-interest always comes first, any supposed “leader” will make choices that are firstly for his and his close kin’s benefit, whether holding onto power, keeping the status quo, maintaining vested interests etc., while the people can go screw themselves. As long as you have the plebiscites looking up their “leaders” for economic direction and planning, this eternal cycle of boom from productivity growth, consolidation of economic benefits for the few at the expense of the rest, mis-management and abuse by law, by fiat, by devaluation, by hidden taxation etc., eventually leading to economic bust, then pushing the blame to someone or something, leading to wars with millions killed, which then clears a large portion of the debts / liabilities in one fell swoop (because your debts are void if your debt-collectors are all dead ;) and hence the balance sheet is reset once again. Then rinse, wash repeat. Its that simple. Really.
Therefore, your human race will NEVER learn, as long as human nature is such. The alternative of deconstructing the social hierarchy will be too drastic for anyone to accept. People have tried communism and it failed, and true democracy of having the government by, for and of the people have now been twisted so far off kilter into just a false democracy of just one meaningless vote every couple of years, with the elected representative yodeling to and charming voters during election seasons, but once elected, hardly bothered with the concerns of the man-in-the-street during the intervening years.
Fundamentally, all the idealistic -isms whether they be socialism or capitalism goes back to grassroots movements whereby the People makes economic decisions for themselves at the local levels, NOT by some big, faceless, organization out in blue yonder. Any attempt to consolidate decision-making at the top of the pyramid implies a pyramid, and in a pyramid, the vast majority of the people INEVITABLY gets crushed near the bottom, in order to support the entire lofty façade.
Yet our “leadership” has somehow been able to enact public health legislation such as pure food & drug laws, sanitation (sewer & garbage) laws, immunization/vaccination laws, quarantine regulations, etc. which have largely made the plagues and epidemics, such as the “black death” and pandemic “white death” (tuberculosis/consumption) things of the past.
There appears to be no plausible reason that similar results could not be attained in economics/finance through the use of analogous epidemiological studies (e. g. Econometrics and Behavioral Economics) and appropriate [enforced] regulation/monitoring.
Grassroots?
Amongst my favourite quotes is: it will be interesting to see how long they will be allowed to keep it when the meek inherit the earth.
People making decisions for themselves is not the solution. A decision is symptomatic of being lost. Ideally people should find themselves and then take it from there. Things will naturally follow. Most of human society’s problems stem from trying to impose the artificiality of human law and order on our natural state. That creates a conflict of interest.
How do you run a company when everyone just does what they wants.?
Your ideal is how the human race started off before they started to congregate in small settlements.
Even in small settlements it doesn’t want to work if everyone wants to do the same thing, someone always has to do the bad jobs that no one wants to do.
In a striking instance of history “rhyming”, CreditAnstaldt’s surviving entity is now a subsidiary of none other than UniCredit.
Compare the above article with one just published by George Friedman.
http://www.mauldineconomics.com/editorial/george-friedman-italy-is-the-mother-of-all-systemic-threats
My family has long standing friendships with folks in northern Italy, and they have been deeply worried about their savings in the Italian banking system for years now. However, so far they have not started to pull their money out of the country in any big way (I think). The disincentives are too high!
I wonder what’ll happen if fear for capital preservation trumps fear of fees and taxes. Will it be a China like outflow, or more of a bank run? Can we even still have bank runs when cash is limited? What would take its place?
I always thought watching a ‘slow motion train wreck’ would be exciting on some level, but observing Europes misadventures is simply depressing.
I guess distance clears the mind, it is obvious that the EU is not working. Like Britain, Italy needs to bow out of the EU and use I-exit as the excuse to reset the banking system.
All these bad loans are a result of a structural default. People/institutions are borrowing as much as possible in anticipation of the eventual outcome, real default. They are using the proceeds of the last loan to pay off the previous one. They don’t care about the debt levels because they all already know they are in the twilight zone. It doesn’t matter and they don’t care anymore.
They cannot fix this without acknowledging the worthlessness of the debt. There is not enough collateral anywhere to fill this hole.
I agree to this extent- Italy leaving the EU and the euro and Germany’s partly explicit and partly implicit backing, would cause such a tremendous crash that this uncompetitive, bureaucrat- ridden economy might have no choice but to undergo fundamental reform.
One way to lose weight is a concentration camp.
Sergio Marchioni head of Fiat- Chrysler has threatened to pull Fiat out of Italy unless ‘it can develop labor practices more resembling those in the rest of the developed world’
It would have to go back to the lira, which would not only not be a reserve currency, it would maybe need EU backing to even be convertible. I.e- there might be such a loss of confidence after such a
move that the lira would cease to be money outside Italy.
During Greece’s famous referendum bluff, with the EU saying ‘call’ international aid agencies had to scramble to line up essential drugs
like insulin, which Greece could not have purchased.
Some agreed to take IOU’s
Swiss giant CIBA: ‘cash’
No Italian real estate would be priced in lira, pre-Euro it was all in US$, then in euros, now back to one of them. Anything but lira.
A stand- alone Italy would be looking, at a guess, of interest rates of 7.5 % to finance its debt. ( I’m taking that out of my…hat because that’s what Argentina had to pay- but it has nowhere near the debt of Italy)
Since under the EU umbrella, it is now paying less than 2%, its debt service would at least triple.
Being unable to finance its government spending- super austerity, also known as reality, could no longer be avoided.
In the bite-the-bullet scenario this is all to the good, because it forces change- but with a huge Communist influence in the bloated public sector you might also get a civil war.
(In case anyone thinks I’m a McCarthy type re: Communists- in Italy that’s what they call themselves)
There is no comparison between Brexit and Italy leaving the euro.
The UK has its own currency, still a reserve currency, (I know some Americans won’t believe that) a more flexible economy and a banking system with issues, but not the insolvency of Italy’s.
While I agree that an I-exit would prompt the EU to act worse than the Mafia, the world of bank is changing rapidly. I disagree that the EU has more credibility than a new Lira might have. Italy can join that other clearing system and orient themselves east instead of west. The west buys most things from the east anyway.
Global changes are coming, yesterday I watched a bunch of central banker flunkies on Cspan, advocating for the repeal of Dodd Frank because it restricts them from bailing out non bank entities without congressional approval. You can smell the next crisis coming while watching the segment.
Why are Club-Med banks in trouble?
I suppose we should start by looking at the bleedin’ obvious.
The EU technocrat’s intellectual superiority means they tend to over-look things that are bleedin’ obvious to lesser beings.
When you impose austerity it leaves people lower down the scale with less money and because they have less money they are no longer able to make their loan repayments leading to NPLs.
Those lower down the scale have less money to purchase goods and services, leading to problems with the companies they used to buy goods and services from. These companies then have less money and are no longer able to make their loan repayments.
These companies in turn bought their goods from other companies, leading to problems with these companies they used to buy goods from. These companies then have less money and are no longer able to make their loan repayments.
The banking systems of all Club-med nations are in trouble.
EU technocrats can you work out what you have done to cause the problem?
The IMF and World Bank have been destroying economies for 50 years with austerity.
It has left a trail of wreckage through South America, Africa, Asia, Eastern Europe and has now arrived in Western Europe.
No one told the EU technocrats.
The IMF is a lender of LAST resort, it is reluctantly called upon when a country can’t borrow money from anyone else. In 1974 when the UK had to go, having been turned down by West Germany, it was shocked that there would be conditions- it had to cancel some social spending and sell part of BP oil.
If you don’t want to go to the IMF, the alternative is simple: don’t go broke.
The World Bank makes very soft loans to basket cases that the IMF won’t touch.
The alternative to it is a money tree.
Luckily there is a new Asian development bank now.
The IMF was the only lender and it always crucified countries if they were so desperate they had to borrow from them.
Their state companies would usually end up in the hands of US companies, austerity and decreasing government spending would massively increase poverty. A few at the top did well by oiling the wheels for a takeover of foreign companies.
Borrow money from the IMF and the country dies, look at Greece. A few at the top get rewarded to encourage them in that direction.
Have a look at the IMF forecast for Greece if you want a laugh.
https://www.youtube.com/watch?v=8YTyJzmiHGk
Richard Koo has provided us with a graph of how it was IMF imposed austerity that killed the Greek economy at about 54 mins.
The IMF forecast is a sick joke.
Germany is the country that this time gets to buy up what was Greece.
Re: a run on banks causing a rise of anti- austerity anti- EU Five Star party.
If they take over then the run on Italy really begins. This comes under the heading of ‘the boat has broken down, let’s swim to shore.’
I doubt that Italians who are anti- austerity (read: an attempt to curb government spending) know what austerity is.
The case of New Zealand is instructive. In the early 70’s it was a far left, socialist economy. One day in 74? the minister of finance got a call: the central bank had ‘ceased foreign exchange operations’
He phoned and asked ‘why?’
Answer: ‘We have no foreign exchange’
I.e., a NZ company needing US$ to buy equipment couldn’t buy them with NZ currency.
But you can’t go broke in your own currency, right.
Yes. the NZ money was still money in NZ, but this was a place that sold, mutton, lamb, dairy, apples and not a heck of a lot else. It needed to buy virtually all manufactures OUTSIDE NZ, for which it needed Forex.
Sir Roger ( he wasn’t ‘sir’ then) and his far- left government had to do a 180 degree turn. Half the staff of the government state broadcaster was let go in one day. The world’s first GST or more precisely VAT (Value added tax) was brought in. It had NO exceptions. It was on food, funerals, kids clothing. Roger explains ‘that if we made one exception, someone would say they should also be excepted and a bureaucracy would be needed’.
One emergency measure in the first week that may wake up some of the ‘you can’t go broke if you print a currency’ folks: The NZ government had a number of embassies around the world. Some of these had credit cards good in US$, UK pounds etc.
The government got them to max their plastic and wire home the proceeds, NOW.
But the sturdy New Zealanders survived austerity and today are doing well- it helps that a relatively prosperous China has developed a love for NZ dairy including a thirst for NZ milk, which they can feed a baby in confidence.
That’s why I no longer live in New Zealand.
If anyone needs a modern day example of the end game of socialism will take a good look at New Zealand. Although I believe Europe will soon provide a more modern day example of why socialism does not work although for all those whom remembered Maggie Thatcher’s words, the problem with socialism is eventually you run out of other peoples money.
Here in the UK we have already had an MP gunned down in the street. I wonder how folks will react when they start losing their jobs, houses and their pension funds start blowing up. I am unsure if the politicians understand the utter contempt in which they are held. When you read some folks online claiming they will hunt some of these crooks down and off with their heads.
I was reading a blog from a connected French resident that had been told that French MPs should not travel round France anymore because their safety could no longer be assured. I am inclined to believe after seeing the video of the German Justice Minister ushered off stage at a rally for his own safety when the crowd turned against him.
Anyone have an estimate (or guesstiment) of how much of the money was lost through outright fraud/looting and how much was lost through “bad banking” practices and ignorance? This being Italy, how much of a factor was “organized crime.”
Italy comprises different states/different cultures all trying to operate under a single banner. It cannot succeed, at least not until the different factions have found a way to resolve their differences.
While the same could be said of other ‘countries’ the difference is that other countries are not Italian!
The Netherlands could be the next country to “get out”, even before Italy.
A move to Netherexit would be very interesting to see.
The Netherlands and Britain can stand on their own financially. This does not mean it is to their advantage, but it is possible.
At least in the short term, Italy can’t.
Barring a huge loan from the IMF or maybe the tooth fairy, an Itexit means the collapse of the Italian banking system, followed by, at the very least, a severe depression.
Oh, there’s a depression now, right?
Read up on The Depression, riding the rods, going to back doors asking for a sandwich etc. etc. In Canada, men were allowed to ride on the top of freight cars. In the US you usually had to hide beneath the car, supported by the brake rods. Sometimes the train would dangle chains beneath the cars to rattle up and shake loose any bums hitching a ride.
‘In Why Shoot the Teacher?’ Max Braithwaite’s account of his stint teaching during the 30s- he is met at the train station by the Superintendent with a one horse trap.
The Super is wearing flour sacks on his feet.
People saying this is like the Depression or even worse than the Depression have no idea.