What’s Keeping Italy’s Government Debt from Blowing Up?

Even Italian banks are dumping Italian government bonds.

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

New statistical data from the investment bank Jefferies LLC has revealed a startling new trend that could have major implications for Europe’s economic future: Italian banks have begun dumping unprecedented volumes of Italian sovereign debt.

Holdings of government debt by Italian financial institutions slumped by a record €20 billion in June — almost 10% of the total — after €9.4 billion of sales in May. As the FT reports, the selling by Italian banks is the most emphatic example yet of a broader trend: banks sold €46 billion of government paper in June across Europe, taking the total reduction since the start of this year to €257 billion.

The banks’ mass sell-off is probably being driven by two main factors: first, as an attempt to preempt a pending Basel III reform package that could eliminate the equity capital privilege for EU government bonds [read: Fears of Italy Doom Loop Resurface]; and second, to position themselves for an anticipated autumn announcement from the ECB that it will begin tightening monetary policy.

“Maybe we are seeing an indication of Italian banks catching up with what their counterparts in Spain have known for a long time — that sovereign debt is not the place to be in a world of rising interest rates, said Jefferies’ senior European economist, Marchel Alexandrovich.

But then: who’s buying it?

The answer, in the case of Italy, is the ECB and its Italian branch office, the Bank of Italy, where Italian bank deposits rose by €22 billion in June and €50 billion since the start of 2017. The ECB “overbought” Italian government debt in July with purchases of €9.6 billion — its highest monthly quota since quantitative easing began.

As Italian banks offload their holdings, the ECB, with Italian native and former Bank of Italy governor Mario Draghi at the helm, is picking up the slack. In doing so, the central bank surpassed its own capital key rules by which member state debt is bought in proportion to the size of each country’s economy. By contrast, the ECB’s German Bund purchases slipped below its capital key rules for the fourth month in a row, which further depressed the spread between Italian and German 10-year debt to 152 basis points, its lowest level of the year.

This spread is artificial, derived from the ECB’s binge buying of European sovereign bonds, particularly those belonging to countries on the periphery.

A report published in May by Astellon Capital revealed that since 2008, 88% of Italy’s government debt net issuance was acquired by the ECB and Italian Banks. At current government debt net issuance rates and announced QE levels, the ECB will have been responsible for financing 100% of Italy’s deficits from 2014 to 2019. That was before taking into account the current sell-down of Italian bonds by Italian banks.

In other words, Italy’s government has grown wholly dependent on the ECB for funding at artificially low rates. In that time, the country has become home to the largest public debt pile in the EU, worth €2.279 trillion in May, despite being the region’s fourth largest economy (behind Germany, France and the UK). The European Commission has repeatedly threatened to impose fines for breaching EU budget rules, but if it ever did, it would be the ECB that would end up paying them.

Clearly, this arrangement cannot last forever. Over the coming months, if Italian banks continue to reduce their holdings of Italian debt, the ECB will have to continue buying these bonds. After all, there’s virtually no one else in the market left to pick up the slack.

But even the ECB has its limits: it can only buy up a maximum of 33% of a given nation’s debt. In the case of Italy, it’s already approaching the 25%-mark. According to Alleston, once the limit is reached, the only way for the game to continue is if over the following six years non-banks — the very same investors who used QE as the perfect opportunity to offload the immense risk of holding Italian liabilities onto the Bank of Italy, and then onto the Eurosystem — increase their purchase activity up to seven times that of the past nine years.

That is not going to happen.

It is for this reason, as well as the unresolved issues in the banking sector, the over €400 billion of Target 2 debt the government owes the ECB, the rising public opposition in Italy to Eurozone membership and the growing likelihood of political instability as elections approach in 2018, that Italy remains the Eurozone’s weakest link. And with each passing day, as the economy grows more dependent on ECB funding, it grows weaker. By Don Quijones.

Desperate Times, Desperate Measures. Read…  Leaked: EU Plans to Freeze Deposits to Prevent Bank Runs

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  29 comments for “What’s Keeping Italy’s Government Debt from Blowing Up?

  1. raxadian says:

    Who wanna bet that Italy will be forced to borrow money to buy back it’s own bebt bonds yet also getting more in debt while doing so?

    • chip Javert says:

      The concept of ECB rules (ECB…can only buy…33% of a given nation’s debt) is laughable.

      As Citi Corp’s Chuck Prince said in pre-crash 2007: “But as long as the music is playing, you’ve got to get up and dance.”.

  2. michael w Earussi says:

    The game is already over, the corpse is dead, it’s just that the body is still kicking (a little) giving the illusion of life.

    Even the ECB cannot finance 100% of Italy’s debt forever, and with the Italian state incapable of ever running a balanced budget (not that the U.S. has any room to speak) when the ECB gets tired of financing it the game is going to collapse along with Italy. That’s when the “fun” starts.

    • fajensen says:

      The ECB will never stop, it will be buying junkier and junkier assets all the way Zum Endsieg – the perfectly stable and fully integrated EUR-Zone!

      If it ever does stop, the derivative portfolio of Deutsche Bank blows up, which will surprise the germans quite a lot because at least the german people truly, honestly, believe that Merkel’s Germany are totally on top of things, the very pinnacle of European commitment, probity, culture and proper organisation — and not at all leveraging the EUR to be running a vendor financing scam against the weaker Eurozone countries to boost the German economy.

      Long Popcorn and Beer, I’d say!

      • GSH says:

        I see it the same way. Once the weaker Eurozone countries fully depend on 100% ECB financing, their last bit of autonomy will be expunged. The people will go along with it because breaking away from the Eurozone would be much too painful for the voting citizen.

  3. Maximus Minimus says:

    Easy peasy; ECB stops buying Italian debt, prices drop, starved investors stampede to buy the debt. Can’t be worse than Argentina.

    • Spanky Bernanke says:

      Not so fast… Why does Draghi continue buying the Italian debt? Investors will only “buy” so much debt of a bankrupt country. If rates go up and prices fall, lower ratings will be declared and that will be the end of the EU experiment. If Dradghi continues buying Italian debt, the Germans will finally pull their nuts out of Merkel’s purse and enforce rules. Even worse, if war breaks out, the money printing will drive investors into REAL assets, not paper of bankrupt sovereigns.

      • Ambrose Bierce says:

        Here’s why you will want to own bonds, while you can buy them on your terms. When there is little buying interest in the bond at auction the price at par is discounted. This means that the government pays you to take their paper. Its a good deal for you and something no one talks about much, government buys their own bonds to put a floor under the price, like you want to sell your corn so you send your brother-in-law out among the bidders to keep the price above a certain level, you see the buyers still need the corn, and they still need bonds. It’s dishonest (gee) but that’s how its done, when they get sick and tired of giving their paper away. The solution of course is to pin all bond auctions at par, or better. So if you bought a bond at discount even though the yield is low, you at least got a discount, but that too will end. All avenues of reasonable investment choices will close, as they have been doing. There is nowhere to put your money, except gold.

        • Remo says:

          Bitcoin anyone? In a world of no options it’s a sane solution. owning that yellow metal looks awfully tempting to a government looking to keep itself afloat

  4. RSDallas says:

    It is my humble opinion that this is why the U.K. Is getting out. Any penalty imposed on the U.K. will not compare to the devestation that will be imposed on the EU members after Italy crashes, then Greece, then Portugal, then Spain. They all represent a sesspool of real stinky crap. The fat lady is signing!

    • Stevedcfc72 says:

      You’re right RSDALLAS the fat lady is singing not signing lol. The EU is in a mess unfortunately, just can’t believe the games which are going on which make it sound like it is doing well.

      Italian Government debt maybe being taken on by the ECB but also the Italian Banks are all being ‘subsidised’ in their borrowing costs with the TLTRO 2 Programme. Unicredit and Intesa the two biggest banks have borrowed over 110 billion euro’s between them (the maximum they can have under the ECB rules).

      Whilst these two banks on paper make money, the other Italian Banks who have this ECB funding borrowing are still making losses as they account for more non-performing loan losses quarter by quarter.

      The loan losses recorded in the first half of the year total 8 billion euro’s. Monte Dei Paschi leads the way with 4 billion losses funded by the Italian Government bailout.

      There is nett roughly another 150 billion euro’s of bad loans-unlikely to pay-past due which haven’t had loss adjustments for – if they get sold at 40 cents in the dollar to private institutions (optimistic), the Italian Banks are sitting on another 90 billion euro’s losses.

      They are relying on interest rates going up to subsidise some of this loss – that isn’t going to happen soon.

      • QQQBall says:

        How would rates going up subsidize losses? It would impact their entire portfolio at lower rates? If rates decreased, that might be marginally positive?

        • Stevedcfc72 says:

          Hi QQQBall,

          I’ll find the article but the presentation showed a 1% increase in interest rates would increase net interest income by 14%.


  5. Gershon says:

    I don’t think Draghi can print his way out of this.

  6. Petunia says:

    The ECB is pumping money into the system to inject some life back into the system, especially important around election time. Soon, all those bonds will be rolled up into an SDR and life will be beautiful once more, for a while.

    • michael w Earussi says:

      Pumping money into corrupt countries is the equivalent of pumping blood into road kill.

      • TJ Martin says:

        Correction ;

        Italy by definition is not nor has it ever been a ‘ corrupt ‘ country .

        What Italy is and has been since the end of WWII is what can best be described as Controlled Chaos verging on Restrained Anarchy with occasional hints of socialism , communism and the rare touch of capitalism

        Why you may ask ? According to the family still living there it all boils down to this ;

        After having ruled the civilized world .. not once ( Roman Empire ) but twice ( Holy Roman Empire ) as well as coming within a hairs breadth of doing it again ( siding with Germany in WWII)

        … only to lose it all each and every time . The general consensus among the Italian population from top to bottom can best be described as apathetic .. having an overall nihilistic attitude of … why bother .. what does it matter … and who cares ?

        And to be honest in light of current events .. I’m not entirely convinced they don’t have it right .

        • Cynic says:

          One of my favourite Italian quotes:

          ‘Why didn’t Mussolini conquer Naples first, before trying to conquer the world?’

      • JungleJim says:

        Not exactly. When you pump blood into road kill it just leaks out onto the ground and is wasted. When you pump money into corrupt countries and their zombie financial organizations, it leaks out to the right people and is useful. See Draghi’s generosity as what it really is largess for the well connected. The EU is a huge exercise in cynicism.

  7. nick kelly says:

    As with Greece, wasn’t this predictable? These places are just not and never have been bastions of accountability, especially financial accountability.
    One thing about the lira and drachma: they were a form of exchange control. If nobody outside the country of origin wants them, it keeps them at home.
    The question for someone with euros in either place is not just which bank is safe but should he have them in the country at all ?
    If either place returns to its former currency, the gov will of course seize all euro accounts.
    One thing about a currency switch, they do it without warning. In some African countries, bags of currency have been abandoned at airports when it timed out.
    In Argentina the gov suddenly seized all $US accounts.
    The Canadian Bank of Nova Scotia once had a presence there, and for months ladies would bang pots outside in protest.
    The bank exited, don’t know if it ever came back.

  8. Anon says:

    When will the Europeans admit that their single currency experiment has been a failure?

    • michael w Earussi says:

      Never, they’ll just blame its failure on someone else (they were obviously stabbed in the back).

  9. Frank says:

    The Herb Stein quote comes to mind,”If something can’t go on forever,it will stop.”

  10. Brian Reilly says:

    Central Bankers, politicians, some professional investors, all are acting as though it is possible to both manufacture synthetic fiat currency forever, and pretend to pay some attention to rules of law and accounting. Regulations limiing debt exposure to 25% can be raised to 33, then 50, then 100 or more. Generally accepted accounting principles and definitions of asset and liability can be similarly eased but… sooner or later it falls apart. Everyone knows there is a reckoning, a real global re set coming. These reckoners are trying to ensure that there is no place to hide. No more “offshore havens” or secret Swiss bank accounts. Will they succeed? Nope. Will the failure be spectacular and frightening and profitable (for the people who make the right moves) at the same time? Yep. Will the average Italian and German citizen be screwed out of all they ever earned, and even their right to substantial votes? Undoubtedly.

    Long popcorn and beer indeed. This is a hell of a show!

  11. Jack says:

    I’m not surprised that this dumping of bonds started in June, when the effects of the country’s severe drought became evident. It’s still roasting hot here and no rain for 3 weeks, the last rain we had here lasted 2 hours and was quickly burnt off. The estimated loss to agriculture is about €3 billion; buy your tinned tomatoes and olive oil now, the price is set to rocket. The drought has merely deepened the country’s dire economic situation – Italians are often saying that Italy is finished.

  12. Rob says:

    Target 2 imbalances only grew slightly in June. But they are at record levels for PIIGS funding.

    Roughly EUR115bn hitting the exits this year.


  13. disc_writes says:

    >the rising public opposition in Italy to Eurozone membership

    There is no significant force opposing the Euro in Italy.

    While everybody agrees that the situation is not tenable, no party or organisation has a viable plan to do something about it.

    Even the 5-star movement has no clue: they will never really go through with their referendum.

    There is only a general feeling that the ship is sinking, and that you might leave for better pastures if you know where to find them, or enjoy the calm as long as it lasts.

  14. ramona says:

    theyre buying their own debt/stock to appear like its doing ok. the financial times admitted to britain doing this in 1909 – that they bought theyre own gvnt bonds to try attract investors and appear like the econeomy was doing well. everybody with a brain can see italy is done. their country is flooded with migrants. they have no economy with things being propped up with endless debt and eu cronyism.

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