Italy’s Banking Crisis Spirals Elegantly out of Control

How to dump toxic waste on the public through the backdoor.

Back during the euro debt crisis, while the ECB was buying government debt from Member States to keep Italian and Spanish government debt from imploding, German politicians fretted out loud about what exactly the ECB was buying. Among them was Frank Schäffler, at the time Member of the Federal Parliament, who in September 2011 said with uncanny accuracy:

“If the ECB continues like this, it will soon buy old bicycles and pay for them with new paper money.”

This is now coming to pass.

Italy, the Eurozone’s third largest economy, is in a full-blown banking crisis. Four small banks were rescued late last year. The big ones are teetering. Their stocks have crashed. They’re saddled with non-performing loans (defined as in default or approaching default). We’re not sure that the full extent of these NPLs is even known.

The number officially tossed around is €201 billion. But even the ECB seems to doubt that number. Its new bank regulator, the Single Supervisory Mechanism, is now seeking additional information about NPLs to get a handle on them.

Other numbers tossed around are over €300 billion, or 18% of total loans outstanding.

The IMF shed an even harsher light on this fiasco. It reported last year that over 80% of the NPLs are corporate loans. Of all corporate loans, 30% were non-performing, with large regional differences, ranging from 17% in some of the northern regions to over 50% in some of the southern regions. The report:

High corporate NPLs reflect both weak profitability in a severe recession as well the heavy indebtedness of many Italian firms, especially SMEs, which are among the highest in the Euro Area. This picture is consistent with corporate survey data which shows nearly 30% of corporate debt is owed by firms whose earnings (before interest and taxes) are insufficient to cover their interest payments.

The reason these NPLs piled up over the years is because banks have been slow to, or have refused to, write them off or sell them to third parties at market rates. Recognizing the losses would have eaten up the banks’ scarce capital. Reality would have been too ugly to behold.

The study found that the average time for writing off bad loans has jumped to over six years by 2014. And this:

In 2013, on average less than 10% of bad debt, despite already being in a state of insolvency, was written off or sold. The bad debt write-off rate varies significantly across the major banks, with banks with the highest NPL ratios featuring the lowest write-off rates. The slow pace of write-offs is an important factor in the rapid buildup of NPLs.

Now, to keep the banks from toppling, the ECB has an ingenious plan: it’s going to buy these toxic assets or accept them as collateral in return for cash.

That’s what the Italian Treasury told reporters, according to Reuters. Oh, but the ECB is not going to buy them directly. That would violate the rules; it can only buy assets that sport a relatively high credit rating. And this stuff is toxic.

So these loans are going to get bundled into structured Asset Backed Securities (ABS) and sliced into different tranches. The top tranches will be the last ones to absorb losses. A high credit rating will then be stamped on these senior tranches to make them eligible for ECB purchases, though they’re still backed by the same toxic loans, most of which won’t ever be repaid.

The ECB then buys these senior tranches of the ABS as part of its €62.4-billion per-month QE program that already includes about €2.2 billion for ABS (though it has been buying less). Alternatively, the ECB can accept these highly rated, toxic-loan-backed securities as collateral for cash via so-called repurchase agreements.

But buying even these senior tranches would violate the ECB’s own rules, which specify:

At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).

Hilariously, the NPLs, by definition, are either already in “default” or “unlikely to pay,” most of them have been so for years, and the borrower is already “deemed credit impaired” if the entity even still exists. But hey, this is the ECB, and no one is going to stop it. Reuters:

The move could give a big boost to a recently approved Italian scheme aimed at helping banks offload some of their €200 billion of soured credit and free up resources for new loans.

But the scheme would limit ECB purchases to only the top tranches, and thus only a portion of the toxic loans. So there too is a way around this artificial limit.

To sell lower-rated tranches to the ECB, the banks can dolly up the credit rating of these toxic-loan-backed securities by purchasing a guarantee from the Italian government, which, thanks to the ECB’s de-facto guarantee of Italian government debt, has a credit rating of BBB-, barely above junk, thus “investment grade.”

That’s good enough for the ECB. A guarantee by the Italian government would transfer Italy’s BBB- credit rating to even the lower tranches of these toxic-loan-backed securities.

Reuters got in touch with Standard & Poor’s, which wants to rate these securities because that’s how it makes its money. And then Reuters reported on this exchange about the “Italian scheme”:

“Standard & Poor’s evaluation of previous deals secured by NPL collateral have typically depended on numerous factors, as different collateral types may pose unique risks,” the rating agency wrote in about the Italian scheme.

“Generally, our credit analysis has focused on ascertaining the expected timing of cash flows and net proceeds from the liquidation of the assets.”

Reuters also cited an ECB source who’d said last November that buying re-bundled NPLs could be an extreme option if the Eurozone’s economic situation became “really bad.”

So now, the situation has gotten “really bad.”

As the Italian banking crisis is elegantly spiraling out of control, the ECB is trying to get a grip on it by buying “old bicycles,” namely structured toxic-loan-backed securities whose underlying loans defaulted, on average, six years ago. In the process, the financial middlemen will extract a ton of money. The public in other countries will get to eat the toxic loans plus the money extracted by the middlemen. And the cherished bondholders of Italian banks are a step closer to their own personal bailout.

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  43 comments for “Italy’s Banking Crisis Spirals Elegantly out of Control

  1. MAS says:

    Blame Globalization for Europe’s problems and everyone else’s problems.
    A very good read ( link below ). GDP is dead, Growth is an illusion. There is too much of everything in on this planet.

    • CrazyCooter says:

      Nothing about how the worlds present monetary/finance/investment/banking structure is designed to thrive in the reality that is both on deck and also the future.



      • MAS says:

        I respectfully disagree.

        The problem is Globalization where we are screwing up the system by exporting our problems to other countries.

        All you need to do is look at and study Japan over the last 50 years, that’s it. That is where the entire planet is going.

        If people think there is something wrong with the current banking system, its because they either do not understand it, or they are poor and want what everyone else has through socialism. Isn’t that why Bernie Sanders is gaining so much momentum. It’s not about who you are, or the man you are anymore, its’ all about what free shit you can give to the masses. He’s an old Hippie who is taking a page from Obama’s election of offering free shit. Simple as that.

        Again, the problem is there is too much of everything on this rock and you cannot keep producing for infinity.

        Lets get into why companies move and why you lose your job. And this is me talking as a business owner. Well maybe if I didn’t have to pay a bunch of assholes 40 or 50 dollars an hour, deal with a Union, pay incredibly high utilities, and property taxes, then maybe I can actually make a buck.. so what do companies do, they relocate to places like Mexico, where its like going back 40 years, where my utilities are next to nothing, my rent is next to nothing, if I lease the land and build a building again next to nothing and I can pay an employee 2 dollars an hour and heck, they are happy ! Unlike here, where you pay them to the moon and they are still miserable, spoiled, entitled SOBs. So again, countries exporting there problems to other countries. That’s the problem.

        • Wolf Richter says:

          Calling your employees “a bunch of assholes” tells me all I need to know about what kind of business owner you are.

        • d says:

          Yes another drag the workers to the lowest denominator through unfair, globalization competition, slave driver..

          High wage rates, good worker conditions, and safety standards along with equally high environmental standards, only become a problem when another supplier is allowed to compete, without funding or complying equally, with those things.

          There is a case for tariffs based on unfair competition, through, poor safety, environmental, and worker conditions.

          India and china can only compete as they are dirty, unsafe, and have slave labour employment conditions.

          If they were forced to comply to the same standard’s, they would not be able to compete even if they only paid their workers $1.00 a day. As the wage, is a small part of the total cost of anything.

          First world slave drivers need to realize that their first-world living standards, Society, and profitability. Can not be long term maintained by paying workers third world rates or maintaining third world employment conditions. Or by mporting everything from third world nations. For very long at all.

        • Mark says:

          If I was your employee and you call me that name I would punch your daylights out. I have managed operations of different companies (successfully) for the past 20 years and the only assholes I met were owners, CEOs, useless teams of middle management and very few employees on the floor.
          What is preventing you to move business somewhere else (different USA state) since you don’t care about your employees anyway?
          Why do you pay them so much?
          You were sleeping all these years and now you woke up and bitch about huge wages?
          Hire me to clean mess, my consulting rate is $190 per hour and success is GARANTIED or I give you your money back.
          How about that, do we have deal, my contract expires end of March.

        • ML says:

          The problem is your problem. Not pcalling the people you have hired assholes – what does that say about your choice – but you doing nothing about it. If you don’t like the amount of profit that you are making as it is, then do something about it. The world doesn’t owe you a living.

  2. OutLookingIn says:

    One must remember that before Mario Draghi became head of the ECB he was Governor of the Bank of Italy and a past managing director of Goldman Sachs, before which he was the Director General of the Italian Treasury.

    Looks like the Italian financial nightmare he had a hand in creating, is going to come home to roost in Brussels!

    • CrazyCooter says:

      When I had my second job (first job was a bit of an interesting bust) I printed out these Bill Joy quotes and had them hanging by a pin in my cube for a couple years.

      My favorite one (which isn’t sourcable anymore – take as you will) was as follows:

      Not enough (software) engineers engage in forward thinking – they drive by looking in their rear view mirror instead of looking through their windshield.

      This advice is simply brilliant and has kept me “on task” my whole life.

      Nothing we have in front of us has happened before – yet the leaders who are leading are acting as if the past is a guide.

      It is not.



  3. Hulbert says:

    If this goes through it’ll take the EU one step closer towards integration into a true federal state. In that sense I’m all for it. It might even be very positive for the markets and economy of the whole eurozone for a while.

    On the other hand, making Germany etc eat losses like this must be counterbalanced with rigorous reforms in Italy! The Italian economic and tax systems desperately need a rejuvenation and simplification. I fear doing these types of back room financial deals ultimately helps the very rich most of all, with debt forgiveness and constructive reform just an unintended side effect if it occurs at all.

    What Europe really needs are grand projects to put people back to work, something from which everyone can draw hope and inspiration for a better future. Something like Atlantropa perhaps, which is a dam across the straits of Gibraltar. Here’s a link:

    But it’ll never be built.. Not for technical engineering reasons but because no one could imagine getting approval from the political apparatus. Atlantropa would be such a wonderful project even if it lowers sea level by just a few hundred feet (endless hydro power, lots of new land, etc).

    But With political power shifting ever more to rich folks, big projects in science and for the benefit of the general populace have been on a downtrend in the west for 70 years now. That’s because monopolies don’t invest in New technologies that would shake up the status quo, just like Banking elites won’t relinquish control of capital back to the people who earn it. No wonder populism and extremism are on the rise.

    • Wolf Richter says:

      I guess, in your book, bailing out bondholders and stockholders with other people’s money (taxpayers) is always a good idea. Because that’s what this and other bank bailouts are: they’re bailing out bondholders and stockholders. They’re not accomplishing anything else.

      • d says:

        If they actually pull this off the way you have written it, the EUR attains a position below the worthless CNY.

        Something akin to the ZWD.

        Spainish banks, sickened the EUR, greece crippled it, it looks like Italy and the ECB together may kill it, or at least it’s remaining credibility.

        Do you really believe Wolfgang and Mutti will actually allow the German taxpayer to be bilked like this?

      • DCR says:

        Bailouts reduce the incentives for the general populace to produce more than they consume (i.e truly save, as real savers are always the ones punished for their efforts), and increase the incentives to speculate as they see others not penalized for their “heads I win, tails someone else loses” mentality. What results is lower market-determined capital investment, more government-determined malinvestment to combat the private sector’s lower saving, lower per capita GDP, and a more leveraged, unstable financial system. Oh, and richer, more corrupt bankers.

      • chris hauser says:

        they are refloating the boat by toptranching a small income stream that will service the securitization, and hopefully the money they pay the banks for the loans that go into the securitization will be lent out to activities that will pay back the loans that were made with loans on the small income stream generated by runoff.

        also known as kicking the can.

        mario draghi is an mit grad, after all.

    • Cashboy says:

      “On the other hand, making Germany etc eat losses like this must be counterbalanced with rigorous reforms in Italy!”

      Isn’t that what they have been doing with Greece?
      That is really going well isn’t it?

    • CrazyCooter says:

      All the Euro need is a political leader with a name that rhymes with “arlemagne” because that dude made a monetary union work in the past!

      Seriously, folks need to read history before they attempt to solve the world’s problems. Personally, I am at the stage where I am grudging accepting that nature selects stupidity (it must confer some evolutionary advantage I don’t perceive) … or I must be stupid … I refuse to consent and attempt to persevere …



    • d says:

      So how do they efficiently drain the med to that level, when they have to Absorb the inflow from the black sea though marman.

      And the generation inflow from the Atlantic before you consider rising sea level at the Atlantic wall.

      Even if you filled the Qattara depression with med salt water, then evaporated the level down and desalinated it from the Nile over time.
      Which is a 2 huge above and below ground canals it is own wright this would not lower the med to the level required..

      Also this concept would desalinate then Black sea/Marman over time. (once what is now the back sea, was a fresh water lake/sea)

  4. Vespa P200E says:

    PIIGS banks squealing again. ECB is merely papering over by buying their sovereign debts but their banks are drowning in NPLs/defaults further choking the anemic growth as banks failures dominoes begin.

    Not recognizing and writing off the bad debts by playing the hide the weenies is coming home to roost the PIIGS banks but they’ll soon be joined out other banks who are facing CDS exposure many times over capital as well as ballooning NPLs = recipe for disaster many times over BS/Lehman debacles.

    Wonder how the US TBTF banks will fare…

  5. ucde says:

    For the 62 billion a month figure, they could give every single person in the European Union (503 million) about 123 Euros per month.

    That’s not enough to live off, but it would be a start. In many places (Greece, and in the rural parts of many countries) and for the less well off, it would be a significant help. I don’t know what the point is of keeping the financial sector afloat anymore… it doesn’t seem to have served anyone outside of itself for the last 10+ years.

  6. (Sigh … )

    If the ECB lends against defective collateral, what is the difference between itself and an insolvent Italian bank?

    (A: there is no difference.)

    What happens when people (depositors) realize there is no difference between the ECB and an Italian (or Spanish) bank?

    (A: runs out of the banks … HEY! We already have runs out of Italian/Portuguese/Greek/Spanish banks. Insolvency is being ‘priced in’ even as we speak!)

    So … how does the ECB making pretend fix the euro crisis?

    (A: It doesn’t … but it’s all coming apart anyway so why not throw the Hail Mary pass and buy some time? If the pass somehow works the ECB is a hee-row. If it fails … it won’t matter.)

    No wonder the brightest minds of a generation want to go cashless … makes bank runs that much harder!

  7. LG says:

    Capitalism finito!

    “Partition Socialista”

    founded 1892 dissolved 1994

    Reinstated 2016

  8. MC says:

    There’s an old saying: if you owe the bank ten grands, you have a problem. If you owe the bank ten millions, the bank has a problem.
    It applies perfectly to this situation on more than a level.

    Greece is the guy owing the bank ten grands. Italy is the guy owing ten millions. Forget debt to GDP ratios: Italy’s sheer numbers dwarf anything Greece could ever come up with even in the days when Athens increased government spending by double digit a year. That’s why the two countries have been treated so differently.

    And Italian banks have long had a problem. In the days when there was a very robust attempt to turn Italy’s economy from export-driven manufacturing to housing and services, banks lent money with complete abandon and both eyes closed.
    The semi-empty or abandoned malls that dot the country from north to south, the empty office towers and the rows of mini McMansions still looking for a buyer were financed without too much thought being given, for example by turning the other way when it came to thinking who would ultimately pay for it all (Italy has long had the third lowest wages in Europe, after Greece and Portugal).
    Banks often kept on extending loans even when it became apparent a project was not viable and even kept afloat a large number of these firms for a few years after 2008, for the simple reason they had so much riding on them. And once the music stopped, undercapitalized small banks just kept on “extending and pretending” by refusing to write bad debt off until forced.

    The fact nobody, most likely not even ABI (the banks’ association), has an idea of the quantity of NPL’s in the system is due to the fact bank directors hold a lot of power in Italy. Some of them undoubtedly wanted to hide their bad calls from their superiors in Milan or Turin, but many more were instructed to do so. The numbers involved far trascend the authority of individual directors.
    All European banks suffer from lack of regulatory capital, but Italian ones particularly so, both due to dwindling saving rates over the past two decades and the sheer quantity of risky assets they hold. Having too many NPL’s on the books is exactly the kind of thing one want to avoid in such an environment.

    Now a little note about eurozone legislators and regulators. For all their saber rattling and bellicose statements, they are coming off as nothing more than schoolyard bullies, and not particularly threatening ones.
    The scheme involving monthly purchases of toxic asset-backed securities will allow Italian banks to quietly dump NPL’s at a steady rate without anyone truly noticing the grand total. I am sure not too many questions will be asked. Of course one may argue the ECB QE program is set to expire soon, but everybody is betting at very least on an extension to December 2017. And Mario Draghi never wants to disappoint financial markets.
    Now: before putting taxpayers from Lisbon to Berlin on the hook for yet more untold billions, eurozone officials should at least have demanded Italian banks and the garrulous coalition of former Communists, daddy’s girls and Goldman-Sachs alumni ruling Italy to perform what the Japanese call tenko (literally “public conversion”).
    This tenko should have taken the form of publicly admitting how many NPL’s are truly in the banking system, down to the last cent, and break them down by just how long they have been non-performing.
    This way Italian banks would have gotten their much needed relief but at the same time those markets everybody proclaims to adore would have gotten the full picture of just how bad with money Italian banks had been. Call it “do ut des” if you will.

  9. CrazyCooter says:

    Oh, I think I have heard this one before ….

    … The Aristocrats!



  10. unit472 says:

    As Draghi stuffs the ECB with junk bonds he will accomplish a major goal of his, turning the ‘Euro’ into a the EuroLira and, mirabile dictu, he devalues it and creates his hoped for ‘inflation’

    Merkel, whose political support is crumbling as a result of her idiotic invitation to invite the world’s ‘huddle masses’, will be in no position to resist the PIGS attempt to ‘mutualize’ their banking losses either.

  11. rich says:

    We’ve seen this move before, right here in the U.S. We watched as the Fed bought billions of dollars worth of CMBS (Maiden Lane 1, 2 and 3), at the insistence of Bernanke and Geithner. Hidden within the Fed, these toxic NPLs died quiet deaths after almost silently imploding.

    Central banks create unlimited amounts of money out of thin air, and can use that money to buy trillions of dollars worth of bank NPLs. The Fed bought hundreds of billions of dollars worth of toxic CDOs from the big six banks, to rescue them from default, through its MBS QE purchases. The banks then replaced these junk mortgages with US Treasuries.

  12. Dan Romig says:

    Ok, so if I get this right, the ECB is going to print money to give to Italian banks in exchange for garbage. What does the BIS say about this?

    Why the f-word would any member state of the EU that has retained it’s own fiat currency want to remain trapped in any collectivism with the morons in Brussels?

    OutLookingIn is spot on regarding Draghi’s past. Hell, he makes Yellen look like a genius.

    As Pink Floyd stated so accurately forty-three years ago, “I’ll see you on the dark side of the moon.”

  13. Chris says:

    Incompetence, corruption, call it what you want, this whole spectacle of simply re-branding toxic assets is a charade. This charade is all part of a bigger lie that the world’s economy is just fine and the world’s central bankers and politicians have things well in hand. Nothing could be further from the truth. The global economy is melting down for the almost the same reasons it melted down in ’08. The solution: continue to socialize the debt of failed banks! To make matters worse the Middle East is about to officially erupt into a regional war and perhaps worse. The politicians and bankers better hope things turn around before matters get worse or they will be facing the real possibility of being lined up before a firing squad. If not for the fact that many regular people would be hurt/killed in the process the thought of a firing squad is not be the worse outcome imaginable.

  14. JR says:

    Moral hazard, (the unintended?) gift of globalization is nothing new. It occurred in 1177 BC towards the end of the Bronze Age and then again 2000 years later in the final years of the Roman Empire. In both cases, an advanced, prosperous global civilization collapsed and a “dark” age, lasting for centuries commenced.

    In each of these two instances – and there were others – the rule of law including respect for the sanctity of contracts simply went out the window. Concepts of personal liberty, private property, expected repayment of debts, etc vanished overnight.

    The result, inevitably, was chaos. Sound familiar? The parallels with conditions today are so disturbing that the common response by many individuals who feel helpless is paralysis and denial. Unfortunately, that’s not going to solve anything…..

  15. Yoshua says:

    The Italian mafia has a printing press. The Italian banks could have just asked them to print 200 billion euros if it wasn’t for the fact the banks prefer digital money and the mafia doesn’t know how to print digital money.

    • d says:

      The Mafia know how to print (Create) it.

      What they have yet to do, is fiigure out how to print (Create), lots of it and get away with it.

      Beyond Phone/Train/Gift cards.

  16. Boyfromtottenham says:

    Hi from Oz. A bit OT, but if (as I was taught in Econ 101) government bonds are supposed to generate “risk-free returns”, NIRP means that they are neither generating returns, nor risk-free! I wonder when holders of these bonds will wake up to this fact, and what they will do then? Or will economists just re-write the textbook?

    • Jerry says:

      Governments bonds risk free!! Really, your economics teacher needs to go back to Uni. In 1932 every European Nation defaulted on their bonds except Britain, well they technically didn’t, they went into a moratorium. China also defaulted. Lets face it very soon you will see multiple sovereign defaults, Turkey, Venezuela, Puerto Rico, Brazil, Mexico, Greece, Portugal, Ireland and Spain. Some of these have already defaulted in reality but for the trickery of the Troika and the dishonest EU with their policy of pretend and extend. That fact is the Euro area is collapsing because of their insane policies.

    • chris hauser says:

      non. they are risk-free. you get what you gave them back. might take a little while, might not buy as much, but the numbers are the same.

      and you can use them as collateral!

      • d says:

        They are no longer risk free, state defaults are on the rise.

        If you hold them to maturity, and they pay no interest you are down the purchase and redemption costs.

  17. nick kelly says:

    Compared to the stuff that is going to be swept under the rug (which is getting so lumpy and beginning to smell) a bunch of old bikes might not be a bad deal

  18. cbfw86 says:

    Did these guys at monetary watch just rip off your article completely?

    • d says:

      Read bottom line

      “Courtesy of Wolf Richter”

      • Wolf Richter says:

        They still didn’t have the right to rip off the article.

        All our content is copyrighted. This is a copyright violation.

        If they want to republish our content, they have to ask for permission, which they will never get.

        But some sites have our permission, and they’re allowed to republish our content.

        • d says:

          Then you should have a (Legal (and perhaps financial)) piece of them.

          As “Courtesy” insinuates they have permission.

          That’s how read it, and I commented on that basis.

        • Wolf Richter says:

          Yes. Unfortunately, it happens all the time. Many of these outfits are overseas. So it’s to throw the book at them.

    • Wolf Richter says:

      Yes they did, these bastards!

      Thanks for pointing it out – I really appreciate that.

      I removed the link from your comment. I don’t want to send them any traffic.

  19. DM says:

    This article and the subsequent comments is pure mind enriching. I love the saracasm employed by some of the commentators.

    It’s my first time straying into the den of wolves. I like it.

    And by the way I have found this page through Business Insider which republished the article.

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