Contagion from Italy’s Bank Meltdown Spreads

There’s a pervasive sense of inevitability to Italy’s banking crisis.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Without a taxpayer-funded bailout that directly contravenes the Eurozone’s new bail-in rules, the world’s oldest surviving bank, Monte Dei Paschi, could soon be out of business. Shares of the decrepit financial entity have long been reduced to a penny stock. So far this year, they’ve lost 78% to close on Tuesday at an inconsequential €0.28.

The closer it comes to its end, the louder the calls for its rescue. Last week saw two out of three of the members of the institutional triad formerly known as the Troika — the ECB and the IMF — lend their support to a taxpayer funded bailout of Italy’s banking system. So, too, did the biggest U.S. bank by assets, JP Morgan Chase.

All that was needed was for Europe’s most influential bank, New York-based Goldman Sachs, to give its blessing. That came on Monday in a report whose conclusion is fittingly Goldman-esque: saving Italy’s banks is not just necessary; it would be a bargain for all concerned. The authors breezily point out that the €210 billion euros of non-performing loans (ha, the ECB says €360 billion and growing every time someone looks at it) on the books of the banks could all be wiped out with the equivalent of just nine months of ECB President (and former Goldmanite) Mario Draghi’s bond purchases.

Here’s the FT:

With the ECB hoovering up €120bn per year of outstanding Italian government bonds as part of its quantitative easing scheme, “by the time QE is over – not sooner than end 2017, on our baseline scenario – around a fifth of Italy’s public debt will be sitting on the Bank of Italy’s balance sheet”, writes Francesco Garzarelli at Goldman…

Bringing the entire net stock of bad loans onto the government’s balance sheet would be equivalent to 9-months worth of BTP [Italian government bond] purchases by the ECB…

With four days for authorities to come up with a plan to inject capital into Monte dei Paschi, Goldman adds that some form of “state intervention is both “likely and, at this late stage, desirable”.

Desirable for whom?

According to Goldman, Italy as a united whole – from the poorest to the richest, the oldest to the youngest – all will benefit from wiping the bank’s — or banks’ — slate clean. An added bonus, the report contends, is that Italy’s troubles are largely contained to its domestic economy. “Italians have lent mostly to themselves: the country’s net international investment position is comparatively small,” the report says.

This is a disingenuous falsehood that has been peddled across multiple media for weeks now. The contagion risk of Italian banks and their bonds is significant, particularly for banks in France and Germany, but also in Spain, the UK, and the US.

However “cheap” the eventual bailout may be — and one can be sure it will be considerably more expensive than the original estimates — it will do little to remedy Italy’s chronic financial ills, which include a stagnant economy, a public debt that exceeds 130% of GDP, a currency that is too strong, a zombified housing market, 35% youth unemployment, and entrenched political corruption. As The Guardian‘s Larry Elliot writes, Italy’s non-performing loans reflect a “non-performing economy.” They are “the symptom of the problem, not its cause.”

By bailing out the bondholders of the banks, all Italy’s government can hope to achieve is to consign its most urgent threat — the collapsing banks — to the back burner for a little while. It will also insulate foreign banks heavily invested in Italy’s financial sector from any undesirable knock-on effects.

But that is all a bailout will achieve: to buy more time, with an obscene amount of public funds.

If bailing out banks were the perfect cure-all to a country’s financial ills, how is it that Portugal’s financial sector is seemingly in need of fresh funds, just five years after receiving €78 billion in bailout money from taxpayers elsewhere?

In a recent report, Barclays warned that Portuguese lenders could need up to €7.5 billion to resolve a “systemic banking crisis” that was bringing the country under close market scrutiny.

“Some banks are in need of a large capital injection,” said Antonio Garcia Pascual, chief European economist with Barclays. “This means any material losses from the sale of Novo Banco [the supposedly good bank spawned from the loins of the now-defunct Espirito Santo] could end up having to be met by the sovereign [i.e. taxpayers], as the capacity of Portuguese banks to absorb them is rather limited.”

In Spain, meanwhile, the banks are not yet begging for public money, but there are ominous signs on the horizon. In a desperate bid to placate the markets, the country’s fifth biggest bank, Banco Popular, recently announced layoffs of up to 3,000 workers, but to little avail. Arguably the most exposed bank to Spain’s crisis-drained real estate sector, Popular’s shares continue to languish at a historic low of €1.22 a piece; two years ago they were worth close to €6.

Even for Spain’s biggest bank, Santander, the problems are stacking up, with significant exposure to the turbulent financial markets of Brazil and the UK, and to subprime auto-lending in the US.

And Spain’s second largest bank, BBVA, is mired down in Turkey, where it owns 40% of the country’s third biggest bank, Garanti. BBVA’s Turkish operations provide a larger share of its revenues than all of its South American operations combined. The bank’s management has already warned Spain’s regulators that “unfolding events in key emerging markets” could have a “significantly adverse effect on the group’s business, financial situation and earnings,” which are scheduled to be published this Friday. It bears all the hallmarks of a crisis foretold.

As the problems mount in Southern Europe (with Greek banks still festering), it is highly likely that taxpayers will be once again, directly or indirectly, via governments or the central bank, be handed the bill for bailing out bank bondholders. The IMF, the ECB, Goldman, JP Morgan Chase, and other banks that own these bonds are already firmly on board. Italians who own these bonds are on board. Hedge funds who’ve by now bought these bonds are on board. Everything is set on go. By Don Quijones, Raging Bull-Shit.

It all began when Slovenian Police raided the headquarters of the central bank and a state-owned bank. €257 million in bank bailout money is alleged to have disappeared. How much money could be made to disappear in Italy’s bank bailout? Read… Is the ECB out of Control?

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  28 comments for “Contagion from Italy’s Bank Meltdown Spreads

  1. All you have here is a crisis of book keeping! The debt remains unpaid. The debt did not exist as money in reality before it was lent as it is lent as a PROMISSORY NOTE.

    The problem begins when the debts cannot be repaid because of the weakness of the economy in which there is lack of demand or buying power.

    All a debt is money that cannot be struck out of existence upon repayment!

    Practice debt forgiveness more readily and all will be well. Under no circumstances make the economy even weaker by taking the non repayment out of taxes. There lies madness.

    • Wolf Richter says:

      Every debt has two sides: the one who owes it, and the one who owns it. It’s a valuable asset for the owner. “Debt forgiveness” destroys that asset of the owner.

      Italian banks are now sitting on that destroyed asset (upward of €360 billion in NPLs). That’s why these banks are toppling.

      Now the question is what to do with the bondholders of these banks. If the banks’ bonds become worthless (via bail-in or “debt forgiveness” as you call it), then watch the effects ricochet around the world. I do think that’s what SHOULD happen. But I doubt they will let it happen. Big banks own these bonds, and they’re worried about their own foundations and executive bonuses.

      • Chris says:

        At the end of the day there will be an obvious conclusion that the world cannot “grow” its way out of this situation. Debt forgiveness in one form or another is the only way out. This mess, which manifested itself in ’08, was never actually addressed except by borrowing more money to keep insolvent banks afloat and shifting this debt to the citizenry. Either the global “leaders” devise a controlled unwinding of this mess or the entire system will simply crash under its own weight. Either way, there will be debt forgiveness.

        • Wolf Richter says:

          Our (in the US) well-established process for “debt forgiveness” is called “bankruptcy.” A whole court system exists to deal with this. It works! (The biggest banks weren’t allowed to go through it during the Financial Crisis … they were propped up instead by the Fed).

          I understand that in Italy, the bankruptcy system isn’t functioning very well, and that is part of the problem.

    • Tim says:

      There are insidious elements lurking in debt, loans made with no intention of repayment, loans to insiders, and loan fraud. Loans to insiders, political connections, go right back to the origins of Lombardi banking, and have brought down banks through history. Bankster looting of shareholders and bondholders is an ancient practice.

      Weakness in the economy is not all that’s going on here.

    • Chip Javert says:

      Talking Cloud

      The madness lies in your ignorance (willful or otherwise) of finance.

      There is no such thing as the tooth fairy or the money fairy (doesn’t matter how much you believe in one).

    • Vespa P200E says:

      Simply put the debt is either paid off or defaulted.

      Banksters are playing the old games of kicking the NPLs can down the road in the hopes of the debtor or economy turning around. Sooner or later NPLs gets out of hand and either the TBTF banks are allowed to fail or the government are forced to bail out using taxpayers money. Silly thing is that the bankster’s profits are privatized but the losses are socialized – worst kind of “capitalism”.

  2. George McDuffee says:

    While it may be desirable to maintain Monte Dei Paschi, I suggest there appears to be no plausible justification for retaining any of the officers, directors, or cadre management in any policy making position. It may be helpful, indeed necessary, that some of the existing high level employees are retained as contract consultants to advise about “assets,” to assist in the reconstitution of the bank and in the auditing the accounts/loans (e. g. “where the bodies are buried”), but all should be gone in a year or two to avoid tainting the “new” bank.

    If it is decided to reconstitute Monte Dei Paschi, a full forensic audit is critical, as is an in-dept independent analysis of what went wrong, if the collapse of the bank is not to be repeated. If fraud and embezzlement (e. g. participation in the Madoff Ponzi scheme) is determined to be a significant factor, rather than mismanagement, incompetence, and bad luck, (as seems likely) criminal prosecution/conviction will be critical.

  3. d says:

    So the bail-in only applies to Cyprus with its Russian customers??????

    Not bailing-in Italian banks to the same level as the Cypriot’s, is treading into very dangerous ground.

    Legally, Political, and Internationally, as the Russian will be screaming foul.

    It may suit Putin to do something about it, by Seizing the assets of a large number of European company’s in Russia.

    Claiming that the seizures in Cyprus were anti Russian and so illegal. And the assets seized in Russia will be used to compensate Russians expunged by the ECB/ Cyprus national bank action’s in Cyprus.

    Putin Will simply make the law’s to make this legal in Russia. If he decides this is where he wants to go.

    Further Bailing-in Cyprus, and not Bailing-in Italy, makes the ECB and the Euro, a bigger joke than they already are.

    • MC says:

      You need to understand a couple things..

      First of all, Italy possesses an arsenal of weapons of financial mass destruction Cyprus and Greece could not even dream about. It took her a few years, but she is learning that arsenal is as much as an asset as a liability: like Israel and North Korea use their nuclear arsenals to obtain advantages at the negotiating table, Italy is using that immense mass of debt as leverage during negotiations.
      Second of all, the Kremlin is playing a very long geostrategic game, like it has always done. It’s not a bunch of oligarchs losing their pocket change that will change their designs: if there’s some good to be had in denouncing the bail-in/bail-out discrepancy, the Russians will do it, otherwise no time will be wasted.

  4. Dan Romig says:

    It is my understanding that Italy has an equivalent depositor insurance plan, called FITD, to our FDIC, and in theory at least, a depositor’s E100,000 is safe.

    This is a simplistic view, but let the markets decide the fate of Monte Dei Paschi. Somewhere, sometime the banks that are insolvent need to quit operating and close their doors. Bondholders and shareholders who’ve invested in this bank need to be left alone to let free market forces determine the value of their holdings.

    It is ironic to read that JPMorgan Chase is lending their support for a taxpayer funded bail out, as Jamie Dimon sat on the Fed’s Bank of New York’s Board of Directors in 2008. Of course, this was when TARP was put in by George W and approved by Congress, and Dimon’s bank got $25 billion. Eight years later, JPMorgan has committed numerous felonies, but it was only given fines for committing crimes by the DOJ, and no one sits behind bars. Great freakin’ system, eh?

    Since Obama signed the Cromnibus Bill on 16 December 2014, JPMorgan’s OTC derivatives are now backed by taxpayers and the FDIC. These opaque financial transactions at JPMorgan alone are so large that they are multiples of the US annual GDP!

    • MC says:

      The big political problem with all these festering Italian banks are not the deposits. It’s the bonds.
      Apart from those owned by foreign banks, far far too many are owned by small Italian savers, especially retirees: with sovereign bonds yielding far less than real inflation, these savers have overwhelmingly piled into bonds issued by their own banks.
      As I’ve said in the past, the Renzi cabinet is doing backflips and moonsaults to make whole bondholders wiped out by four local banks defaulting late last year for purely political reasons: not only one of his chief minister’s family is heavily implicated, but those savers are overwhelmingly from areas his own party has long considered “fiefs”. Should these bondholders be forced to eat their losses, they may even switch their vote…

      And I’ll be brutally honest here: MPS is a bank that has long been very close to the old Communist Party, which then morphed into the present ruling PD. It has long financed munis and other local governments without caring too much about collaterals or credit rating as long as they flew the “right” flag.
      It has already been bailed out twice and the management is sure they will always be bailed out one way or there, if not for political reasons at very least to prevent more scandals from surfacing.

      An idea that’s been floating in my head is Italy will directly swap sovereign bonds for MPS ones. MPS cannot and will not be saved as a whole (some core assets may be salvageable, but that’s all) but that moment can be deferred a few years in the future by spending enormous quantity of money, something the Italian government can get as cheaply as never before courtesy of Mr Draghi and his German enablers.

  5. Don Macg says:

    So let it fail. That’s how capitalism is meant to work. Bad companies go bust. Well managed companies benefit. In the long run, this is good for everyone.

  6. Petunia says:

    We live under a Frankensteinian economic system. Monte Dei Paschi is a putrid limb they are unwilling to amputate. This monster bears no resemblance to the original creation, capitalism.

    Nobody ever talks about these bailouts in terms of them being the destruction of capitalism. Instead the bailouts are always depicted as being the salvation of capitalism. We have a totally broken economic system because we have regulated the foundational principles of capitalism out of existence. Now we have Frankenstein.

  7. Robin says:

    Hi Wolf,

    An important addition which seems to escape the attention of most is that the bail-in rules (BRRD) are applicable only(!) to insolvent banks. As much as belief may defy us, Monte dei Paschi is currently not (accounting wise) so.

  8. unit472 says:

    I admit I am not up on investing in Italian bank or sovereign debt but the handwriting has been on the wall for a while now. The ECB began its ‘unconventional’ monetary policies when Italian government bonds were nearing 7% and shoveling money into Italian and other banks via LTRO from at least 2011 too. Who in the hell is still holding onto bonds from MBS. People have had years to get rid of these hot potatoes so if they are still holding this junk let them eat the losses.

  9. nick kelly says:

    OK -the root of the problem is a ‘non-performing economy’.
    Why is it non-performing?

    The same reason the French, Greek, Venezuelan, Russian, etc. etc. economies are non-performing- too much interference by the state.

    The economy is large market, with thousands of individual markets. One of the things traded in the market is labor- but these economies are notorious for labor immobility.

    Every one in the US and Canada is aware that public sector jobs are ‘better’ than than the same job done in the private sector.
    But in France the public sector job isn’t just desirable- it’s the ‘dream’ job
    a term we associate with a successful entrepreneur doing what he loves.
    As one pundit has put it: In France the state has eaten the economy.

    There is a common thread in a lot of this banking ‘bail out, bail in’ critique, especially from the comments. The disease is seen as a symptom of capitalism.
    But in classic capitalism, i.e, the free operation of markets, there are no bailouts, or subsidies.

    If the root cause is a ‘non-performing economy’- it can hardly be laid at the door of classic capitalism- which would see the dismissal of huge swaths of non-productive public sector workers, the removal of hundreds of agricultural subsidies, etc.
    But wouldn’t this be austerity? it would be for the public sector, but the fat in the public sector comes at the expense of the private sector.

    BTW: a few years back one young lady who had ‘made it’- got a life time position with the French civil service- did manage to do the impossible- she got canned. She went public with the story that her office didn’t actually do anything.

    • Petunia says:

      In the real world there is no such thing as pure capitalism because unfettered capitalism is inconsistent with a moral democratic society. Bailouts and subsides can exist but they should be decided on by the majority and not imposed by those in a position to benefit exclusively. The top 1% owning 90% is not a sustainable political reality in a free society. If the 1% want safety and security they had better share the capital. In the end they will either feed the poor or the police state.

  10. Sound of the Suburbs says:

    Mario and the ECB are destroying the Club-Med banks.

    Mario’s austerity is destroying the economies and banking systems of the Club-Med nations and the collapse of the Euro doesn’t look far off.

    Japan spent twenty five years in a balance sheet recession and it learnt a lot.

    They found out what to do:

    You need fiscal stimulus, monetary stimulus doesn’t work and austerity makes them worse.

    Who’s a silly old Mario?

    Ben Bernanke and Janet Yellen read Richard Koo’s book and ensured the US didn’t go over the fiscal cliff.

    Can someone get a copy of Richard Koo’s book to the ECB before it’s too late?

    • Sound of the Suburbs says:

      Find out what Bernanke and Yellen know but that silly old Mario doesn’t:

    • nick kelly says:

      It’s almost universally agreed among economists (a rarity) that Japan’s efforts so far have failed.
      What it has done has painted itself into a financial corner- a black hole.
      One example of its desperation- the government ordered the state pension fund to buy stocks, endangering the actual lives of retirees.
      Japan needs more than stimulus- its birth rate is the lowest in the world.
      Effectively, only half the population, males, are available for work beyond secretarial and low level service jobs.
      Re: fiscal spending- per capita- Japan has a construction industry far bigger than the US. Visitors notice that there seems to be no corner
      without a concrete something or other.
      This place does not need more infrastructure, the usual synonym for fiscal stimulus.

      • d says:

        Japan is in that corner as cultural it is trying to avoid the cultural fallout from the bankruptcy’s that go with the NPL windup.

        The Japanese Bank’s are waiting for the private and small debtors to naturally die. Rather than prompting their suicides with Bankruptcy’s.

        The Japanese can be VERY patient, sometimes.

      • Sound of the Suburbs says:

        You didn’t watch the video.

        Japan blew itself up in 1989 with a real estate bubble.

        The US blew itself up in 1929 and 2008.

        1929 – margin lending into stocks
        2008 – mortgage lending into real estate leveraged up with derivatives for global contagion.

        Irving Fisher looked at the debt inflated asset bubble after the 1929 crash when ideas that markets reached stable equilibriums were beyond a joke.

        Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

        Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today.

        Steve Keen saw the debt bubble inflating in 2005.

        There are those that knew and the clueless bankers, central bankers and mainstream economists that didn’t know what hit them.

        2008 – “How did that happen?”

        Mainstream neoclassical economists are a waste of space.

        Canada and Australia will be blowing themselves up too soon when they go through their “Minsky Moments”.

        Their clueless bankers, central bankers and mainstream economists won’t know what hit them.

        • nick kelly says:

          Oh no doubt there will be a real estate correction in Vancouver for one- but the Canadian banks are the soundest in the world. The economy is quite diversified- at times vehicle production has exceeded US production. You know all those Dodge vans- for a decade the only alternative to VW’s under powered bread box – all made in Canada- three shifts for about 20 years.

          Australia- different story. I’m not sure how much different but it had way too many eggs in the iron ore basket.
          One difference: Canada can ‘eat’ some of the energy it can’t sell
          Australia can’t do the same with iron ore.
          And the last vehicle maker, Ford, is leaving.

        • robt says:

          nick kelly:
          The following link provides analysis of the Canadian Banks performance during the 2008 crisis. The information took years to get under ‘Freedom’ of Information laws, unlike the States, where everything is out in the open. It’s not pretty.

        • nick kelly says:

          No doubt the 2008 crash caused the Canadian banks some grief- just no where near as much grief as the US banks, Citi etc.
          BTW: Goldie lost half its value in a week and had to be reincarnated as a bank to qualify for Fed money. The US banking system was going to collapse ex Fed rescue as it did in 1930-34 when several thousand went under taking much of their deposits with them. No one lost a dime in a Canadian bank.
          An excellent piece in Vanity Fair: The Week Goldman Almost Died.
          I am not saying the Canadian banks are without stain, they are just preferable to some very dirty shirts.
          Since this is not a search for the Grail- but a ranking of available options, your comment left out important information- which bank(s) do you recommend?

        • d says:

          “which bank(s) do you recommend”

          Be realistic in the, NIRP, Bulk NPL world, we live in.

          No bank is recommendable as they are all lying about the state of their NPL portfolios and the off balance sheet liberality’s.

          FDIC (Or whatever the national equivalent) is great if the hit is controlled, or individual, if the system goes down FDIC will go with it.

          At the end of the day. FDIC is still an insurance. Insurance entity’s are allowed to fail, if they must pay too much.

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