Fear of Contagion Feeds the Italian Banking Crisis

At first, deny, deny, deny. Then taxpayers get to bail out bondholders.

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

Spain’s Banco Popular had the dubious honor of being the first financial institution to be resolved under the EU’s Bank Recovery and Resolution Directive, passed in January 2016. As a result, shareholders and subordinate bondholders were “bailed in” before the bank was sold to Santander for the princely sum of one euro.

At first the operation was proclaimed a roaring success. As European banking crises go, this was an orderly one, reported The Economist. Taxpayers were not left on the hook, as long as you ignore the €5 billion of deferred tax credits Santander obtained from the operation. Depositors and senior bondholders were spared any of the fallout.

But it may not last for long, for the chances of a similar approach being adopted to Italy’s banking crisis appear to be razor slim. The ECB has already awarded Italy’s Monte dei Paschi di Siena (MPS) a last-minute reprieve, on the grounds that while it did not pass certain parts of the ECB’s last stress test, the bank is perfectly solvent, albeit with serious liquidity problems.

By contrast, Popular was also liquidity challenged but, unlike MPS, it passed all parts of the ECB’s 2016 stress test, which shows you how ineffectual these tests are — and how subjective the resolution process of a European bank can be.

In a speech to the Italian Banking Association on Thursday, the Vice President of the ECB, Vítor Constâncio, suggested that under certain circumstances, it might be wiser to save a bank than to resolve it. What’s more, taxpayers should be called upon not only to save banks like MPS but also to make whole all holders of the bank’s subordinate debt, under the pretext that they were misled into purchasing them (as indeed some retail customers, but certainly not all, were).

A taxpayer-funded bailout of bondholders is also on the cards for the two mid-sized Veneto-based banks, Banca Popolare di Vicenza and Veneto Banca, which have already received billions of euros in taxpayer assistance. Italy’s Minister of Economy Pier Carlo Padoan continues to insist the two banks will not be wound down. This is the same man who insisted last year that a) there would be no need of any future bail outs; and b) Italy did not even have a banking problem on its hands.

Padoan has no choice but to deny all rumors of a bail-in; otherwise there would be a massive rush for the exits. In the weeks and even days leading up to Popular’s collapse, Spain’s Economy Minister Luis de Guindos repeatedly reassured investors that the bank was perfectly safe and solvent. All the while government agencies, including Spain’s social security fund, and regional government authorities were emptying the deposits they held with the bank as fast as they could. The total is unknown but it certain ran into billions of euros.

To avoid a similar fate, Banca Popolare di Vicenza and Veneto Banca were instructed by the European Commission last week to find an additional €1.25 billion in private capital. That money still hasn’t arrived, and now Italy’s government is trying to persuade the European Commission and the ECB to water down the requirement to €600-800 million, while also urging Italian banks to chip in to the bank rescue fund. If they don’t and the two Veneto-based banks end up being wound down, they will have to cough up as much as €11 billion to refund the banks’ depositors.

If the money is found in time, another bailout will proceed with the ECB’s full blessing. As Constâncio reassured Italy’s senior bankers, the ECB’s rules on bank resolution allow for precautionary recapitalization of banks by the public sector in cases of significant financial stability concerns. “We have to bear in mind that it is not only direct public support for banks that has a cost for taxpayers, but also financial instability – indeed, the costs of the latter may, in some circumstances, be higher,” he said, invoking unpleasant memories of the global fallout from the collapse of Lehman Brothers.

As Constâncio well knows, in Italy financial stability concerns are off the charts. So chronic and widespread are the banking sector’s structural problems that there is a very real risk that bailing in one or two midsize banks could prompt depositors and investors to move funds from weak banks to stronger ones (including banks outside the country), accelerating liquidity stress and even bank runs.

Even in Spain, which already restructured its banking sector years ago at a total cost to taxpayers of around €300 billion (including government guarantees), it didn’t take long for contagion to spread after Popular’s collapse. The most affected bank was Liberbank, Spain’s eighth largest lender, whose shares collapsed by a third in the three days following the bail-in of Popular. By Monday morning Spain’s stock market regulator, the CNMV, was sufficiently spooked to institute a one-month ban on shorting the bank’s shares, which, at least for now, seems to have stalled the rout.

In Italy, the contagion from a banking crisis would be a lot more difficult to contain. That’s the main reason why MPS was given such a generous stay of execution. If Banca Popolare di Vicenza and Veneto Banca are also bailed out with public funds, the message from the ECB will be resoundingly clear: banks will not be wound down if the banking system they operate in is deeply unstable. It’s a whole new variant of moral hazard: as long as the banking system is in terrible shape, the bank investors will be bailed out with public money. By Don Quijones.

Liberbank’s stockholders and junior bondholders fear a “bail-in.” Read…  Is Another Spanish Bank about to Bite the Dust?

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  40 comments for “Fear of Contagion Feeds the Italian Banking Crisis

  1. Tyronius says:

    Why do I get the feeling this is only the beginning of an enormous Trainwreck that will spread not only throughout the weaker EU countries but ultimately around the world as the collapse first good, then leaps from region to region?

    How could Asia or the Americas avoid getting sucked down with them? I’ve been expecting an economic correction here in the States sometime within the first year of the new administration and European banking crises could easily be the match that starts the fire here. Avoiding such a scenario would be high on the list of things to do for any normal White House, but however one may feel about Mr Trump, this is not a normal administration.

    • cdr says:

      1) Absolutely true. The banking crisis would have been less likely if interest rates reflected actual risk. The ECB and QE distort the price of money and subsidize the Europroject with monetized debt. Of course Italy will fail and so will the rest of the Eurozone. The only way not to fail is if they begin to live withing their means. It won’t happen.

      2) Italy and all the countries in the Eurozone are democracies. They voted people into office who support using the ECB for a free lunch and they keep them there. Nobody is in obvious favor of ending ECB QE although an occasional official mouths something mild and then goes and hides.

      3) The project is designed so that it can not succeed without monetized debt filling the cracks and shoveling more in when the cracks grow larger. Target2 imbalances are one byproduct. Negative rates are another.

      4) Since Italy and the rest of the project benefits from financial engineering that is designed to fail, and they readily support the free lunch they think they are getting from it, any remedial cost thrust upon the citizens to repair the damage is fair and just. This includes bail ins, taxpayer supported bail outs, negative rates, currency confiscation, and whatever other ideas are thought up. In effect, this decay is an alternate method of taxation.

      5) The day the Eurozone fails, prepare for the mother of all liquidity crises world wide. Equity prices will fall hugely. $Trillions of debt will reprice lower. Crooks will try to get another Fed QE program off the ground and try to become trillion-airs from it. The proper cure for a liquidity crisis is adding liquidity in the form of business working capital and forcing banks to make it available, not adding to idle bank reserves or trickle down equity wealth. The stock market will recover quickly on its own. Debt not so much.

      Actually, all I wrote should be obvious.

      • RangerOne says:

        From my limited understanding of the euro zone, all the countries with the least exports are basically destined to fail, greece, spain, itally. BasI call giving up control of an independent currency makes them unable to invidually deal with recessions.

        • cdr says:

          Yes – you got it in 1 try. Their interconnections and inflexibility are their weakness. Their painting over of the problem with BS, negative rates, and debt monetization is what will end them. Time is the unknown. Inevitability is certain.

          But, this will be the fail people remember one thousand years from now. 1929 will be less than tulips from that perspective.

          A decade ago AIG was considered a systematic risk. How does that compare to the debt bubble of a continent that was massively overvalued because of endlessly printed money? Yet people put real savings into the same debt because there was no other alternative.

          The ultimate effect of the collapse is almost unimaginable.

          Fortunately, it’s only money. Once people of the Eurozone accept the fact they are all newly broke, carpet baggers will swarm and profits will be made. Life will find a way.

        • cdr says:

          ps: just found B5 on go90 for free. Woohoo.

        • intosh says:

          cdr, you over-estimate the masse’s wisdom — they will forget within a hundred years.

  2. John Doyle says:

    Where’s the money to pay for the bailout coming from, since taxpayers are in no condition to foot such a bill? The Eurozone nations cannot create currency and I read the EU cannot do it by law either. Probably they will have to break any such law. There is no Treasury, so it’s all a huge destructive mess.

    • andy says:

      The EU is funded by guarantees from constituent nations, not cash or loans. But once loans the EU makes go bad, the guarantees are called in – hence the EUs uncanny interest to ensure Greek loans are always rolled over and never go bad.

      • John Doyle says:

        OK, but guarantees are confidence based. It’s a flimsy support. It’ll come unstuck soon enough. Germany aside, most nations are not in the business of creating value as in real goods etc, but in asset inflation through financial manipulations. It looks like wealth but in reality it’s just a ponzi operation by big banks. The EU needs a central bank and Treasury, with the same powers they have in MS nations.

  3. Junglejim says:

    In simple English, the Italian banking system appears to be circling the drain….. But while Italy may be the worst, none of the Club Med group is healthy, so who will be next ?

  4. chip javert says:


    I love reading your reports.

    I would point out that only sentient being can experience a “moral hazard”; I doubt EU banks qualify.

  5. Jarhead John says:

    Dear Italian friends…Look southeast to a country called Greece…safeguard your Euros NOW!!!

  6. Kf6vci says:

    Some are more equal than others. It’s “Animal Farm” time!

  7. raxadian says:

    Decades ago the bank would have been bought by the Italian state, but of course you can’t do that nowadays. You would be a commie!

    • IdahoPotato says:

      If you aren’t allowed to short a bank’s stock, it isn’t capitalism. Free markets are free only until they aren’t.

  8. R Davis says:

    They are playing the game of pass the booby trapped parcel.
    Hoe funny they all are – pretending to be so civil.
    The banking industry is way too big.
    There was never enough monetary or asset value to sustain so many banks.
    So they took worth to infinity & became fake billionaires & trillionairs.
    There are not enough assets on planet earth to cover the debt that they have ratcheted up.
    A massive downsizing was in order as far back as 2008 & the GFC .. not crisis but FIASCO .
    Today – 10 years later – what should have happened then is in play.
    The fall from Riches to Rags of the majestic with the Midas touch.
    Bon voyage a l’infini.

  9. R Davis says:

    Eurogroup agreed for a 8.5 billion euro bailout ………..bla, bla, bla, bla.
    Oooo – the lucky Greeks.
    not so fast pal.
    The 8.5 billion will not go to the assist Greece & it’s people
    What kind of scam is this – debt piled upon more debt for Greece.

    • intosh says:

      Right. According to Yanis Varoufakis, 91% of first bailout money and 100% of second bailout money, as well as 100% of third bailout money, advertised as going to Greece, actually went to EU banks. So effectively, German, French, etc, taxpayers’ money going to EU banks. The great wealth transfer. Baron robbers robbing nations. If only the masses knew what has been going on and what the consequences will be, they would be on the streets with pitchforks dragging the crooks out to hang and burn them.

  10. R Davis says:

    Max Keiser – on The Keiser Report told of bankers throwing themselves off tall buildings after 2008
    It was deemed suicide by the establishment.
    Even the banker who committed suicide by throwing himself on to the road in front of a soccer mom’s van.
    they were dangerous times & they have returned.
    Never come between a rich man & his money.

    • Frederick says:

      Look for nail gun sales to increase exponentially and the velocity of money to plumb new lows shortly

  11. Stevedcfc72 says:

    Yesterday two American hedge funds pulled out of potentially buying 26 billion euro’s of loans off Monte De Paschi at 20% value – effectively a 21 billion euro loss. That shows you how bad some of these assets are.

    One of the Veneto Banks has a 700 million repayment to make in July, they haven’t got the cash. The government want to defer it but this will cause major issues with their bondholders.

    One question which has bugged me how can a bank be classed as solvent if it has serious liquidity problems. Cash is king,if it hasn’t got the liquidity to pay its bills etc etc then its technically insolvent.

    • cdr says:

      “One question which has bugged me how can a bank be classed as solvent if it has serious liquidity problems. ”

      Great question … it can serve as the fulcrum for giving you the ability to read minds and see the future. Seriously.

      We’re going to use a binary decision tree. It’s a series of yes/no questions to the greatest extent possible. At some point later, for really complicated problems, probabilities and more than 2 choices may enter the picture, but we’ll ignore that for now.

      When you follow a binary decision tree, the path not taken falls off. You ignore what didn’t apply.

      Now … why is a bank considered solvent if it really isn’t? (first you must define the question clearly and crisply.)

      Declare insolvent causes problem – yes/no

      yes: big problem – yes/no

      yes: can big problem be fixed: yes/no

      yes: can it be fixed quickly, easily, cheaply: yes/no

      no: would fix cause other problems elsewhere: yes/no

      yes: would they be a big problem to fix: yes/no

      yes: would those problems cascade into bigger problems: yes/no

      yes: would careers of top important people fail if problems fixed: yes/no

      yes: can they be painted over quickly and hidden: yes/no

      yes: if you stall long enough can they become some else’s problem: yes/no

      yes: Paint over problems. Stall.


      Follow this pattern and you have a fail-safe and foolproof BS detector.

      • Stevedcfc72 says:

        Thanks CDR,

        Great answer and totally true. I’m afraid the BS detector will be in full swing with Monte and the two Veneto Banks this week.

        Interesting one on Banco Popular before the news came out about them being sold for one euro all public institutions-local authorities took their money out of Popular.

  12. unit472 says:

    Santander is a systemically important bank so the Spanish government saddles it with Banco Popular. Meanwhile its US subsidiary is loaded with subprime auto loans and its British branch is facing a Brexit environment with a crippled government at the helm. Any bright spots anywhere?

    • cdr says:

      “Any bright spots anywhere?”

      Wait for the Eurozone fail then buy the dip. That’s my plan. Never waste a crisis.

    • Wolf Richter says:

      Bright spot anywhere? Sure…. Santander was able to offload part of its Santander Consumer USA in an IPO in 2014, with the US public transferring its money to Banco Santander SA in Spain for the privilege of owning a slice of it. Shares have since plunged 52% from the IPO price, and more from their peak.


  13. Sound of the Suburbs says:

    The Americans discovered the Central Banker’s soft spot and when you apply pressure here, the taxpayer bailouts get returned in no time at all.

    Lesson One – You give conditional loans to the banks that have to be paid back.

    Lesson Two – Start ramping up the pressure on the bankers by making these loans ever more onerous and hitting them where it hurts in their remuneration.

    In no time at all the bankers will be crying to the Central Bank about how unfair it all is.

    Bingo, you’ve hit the Central Bank soft spot.

    The Central Bank then clears the bad assets off the banks, the banks pay back their loans and the taxpayers money has been refunded, leaving the government free of the bankers debts.

    The independent Central Bank has a soft spot, apply pressure here and their magic money tree can dispense cash in your direction.

  14. Petunia says:

    I asked about the deductiblity of the losses on one of your last articles on this topic. I think it makes a difference on how the losses may be viewed. If the losses are tax deductible, the losses can be recovered through credits on future taxes. This is not a great substitute for the loss of liquidity but it is better than nothing.

    Can Spanish and Italian taxpayers deduct these losses?

    • cdr says:

      Assuming tax deductible loss or expense:

      If, for example, you lose $100 and your tax rate is 20%, you get $20 off your taxes. Better than zip, but meh. You’re still down $80.

      • Petunia says:

        You are assuming they cannot carry forward the loss, if it is deductible. This could allow them to recover the entire loss over time. The tax law matters in how these losses are viewed.

        • cdr says:

          No! Not even close. You missed that question.

          No loss or expense is 100% deductible from the TAX BILL. None. Then it would be called a refundable credit, not a deduction. The IRA deduction allows you to deduct $xxx from INCOME, not the tax bill. Instead of reporting $25,000 you report $20,000 if you deposit $5,000. Your tax bill IS NOT reduced by $5000.

          Investment losses work the same way, assuming they are permitted as deductions. Some have very complicated rules.

          Business expenses and tax deductible losses work the exact same way. You subtract the loss from income and pay tax on the remainder.

          So, as I said, if you take a $100 loss, and your tax rate is 20%, you are still $80 in the hole. It does not matter how many years of carry forward it takes to declare the loss or, in the case of charitable deductions for example, the expense.

        • cdr says:

          correction: refundable credits are a subset of tax credits. At the very least, writing the expense off against the tax bill is called a tax credit, not a deduction. Deductions are called deductions because they are offsets to Income.

          A refundable credit allows you to make money on the deal. The govt might even send you money back. The Earned Income Credit is still a refundable tax credit, I believe … it’s been a long time since I studied taxes or worked with them.

    • Don Quijones says:

      Hi Petunia,

      The answer, at least for Spain, is yes you can, but you can only deduct up to 20% of the losses you register in the bail-in. In 2018 the limit goes up to 25%. So there is some consolation, but not that much.

  15. Rates says:

    There’s no fear. I’ll tell you what fear looks like: Italian yield north of 7%.

  16. MC says:

    The present paper ediction of Italy’s bankruptcy code runs at 950 pages. Nowhere in it is written banks, big or small, are exempted from bankruptcy procedures if they are struggling to meet the obligations.
    Banks have gone bankrupt in Italy before (see Banco Ambrosiano) and to last check the country has not disappeared in the pit of Hellfire we are guaranteed will engulf us all if whole countries don’t rescue banks, carmakers and others from their own greed and stupidity.

    In spite of the present PR government and its sycophantic media, Italy is like most other countries in Europe financially exhausted. Or, to be more precise, the country is akin to those firms which haven’t got five grand to pay a bill but which apparently have no problem buying a big SUV for their owner and another for his wife (on payroll, but never seen anywhere near the office) every couple of years. There’s plenty of money to build high speed railways while ordinary railway bridges, those carrying 95% of the traffic and passengers, crumble due to “lack of funds”.
    The country cannot afford to rescue any bank, at least not without being fully at the mercy of Frankfurt. The last strength was spent bailing out Banca Etruria and her sisters so the Renzi and Boschi families could avoid being shaken for their last ill-gotten penny and sent to jail wholesale like they so richly deserved.

    Right now there are rumors France’s big State-controlled banks may be convinced to buy Veneto Banca and Popolare di Vicenza. But at what price? Not only they want a big discount on the price tag, but also want billions in deferred tax credits and a big chunk of NPL’s to be taken over by somebody else. They hold the higher ground and they know it.
    Intesa, pretty much the only Italian bank healthy enough to even think about such a takeover, has asked for very similar conditions: a big discount on the price tag, huge tax credits and NPL’s to be removed before the takeover.
    Needless to say both Intesa and the French have made abundantly clear thousands of once unfireable political hires working as bank employees will have to find themselves a new job. Few will shed any tears.

    • Stevedcfc72 says:

      You were right reference Intesa they’ve offered one euro to take over the good stuff at the two Veneto banks lol.

      If there is any of that left.

      Friday we should find out whether this is going to be approved. The more I read into it there will be an element of state aid involved, surely the ECB can’t allow it if there is.

  17. Hugo says:

    I totally dont get why they just wont print the f*** currency to bail out the banks as well. The ECB has printed well into the trillions now to bail out countries. To harvest some value by bailing in some and printing for others (read Italian banks) makes no sence to me. Just print and inflate for all. To me its totally (and criminally) insane to say, well we print for the Italians (and then some) but not for the Spaniards. Totally disgusting and totally not credible. That so many take the ECB serios makes me ask if they are sane at all. Printing will commence, that is a given since Target2 inbalances will remain. As all previous tries have proven in European history. Utterly disgusting. Got gold?

    regards, Hugo

  18. nick kelly says:

    DQ: Both yourself and WR seem to think there should be at least by Canadian standards a lot of independent banks to ensure competition

    In a country with a strong economy like the US this might be so although I think 4000 + separate banks is far more than enough to generate competition. The savings from consolidation might allow more branches in small towns.

    However in the case of this never ending saga in Italy and Spain, I think you can make the case for the exact opposite: the banks should be nationalized and rolled into one.
    This would be a big complicated job with lots of loose ends to tidy up but it would enable the people trying to stabilize the system to focus.
    You would still need lots of cashiers and middle management, but you
    fire a thousand or so of the big fish.

    As it is, we have no idea what next month will bring.

    It’s death by a thousand cuts, or in the case of Italy, 500, the number of independent banks.

    I am something of a right winger but when it ain’t working it ain’t working.

    • Don Quijones says:

      Hi Nick,

      You may have a point regarding Italy, though there are many other causes to Italy’s banking problems than the mere number of banks (e.g. corruption, poor quality of collateral, bankruptcy law, economic stagnation), but as far as the Spain is concerned, it’s already home to one of the most concentrated banking systems in Europe, having gone from around 40 banks 10 years ago to around 10 today (and the number keeps dropping). But as the collapse of Popular and Liberbank’s recent troubles have shown, the problems are far from fully resolved.

      As Wolf has said, the big challenge is not resolving the small ones, but the much larger ones that can infect the whole system.

Comments are closed.