Financial Storm Clouds Gather Over Italy

Wishful thinking may not be enough.

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

The financial markets have been exceedingly calm in Italy of late. At the end of October the government was able to sell €2.5 billion of 10-year debt at auction at a yield of 1.86%, the lowest since last December — an incredible feat for a country that four months ago witnessed a major bank bailout and two bank resolutions, and that has so much public debt that it spends €70 billion a year to service it, the world’s third-highest.

And there’s the ECB’s recent decision to slash its bond buying from roughly €60 billion a month to €30 billion as of Jan 1, 2018. Then there’s the over €432 billion of Target 2 debt the government owes the ECB, the growing likelihood of political instability as elections approach in 2018, the recent referendums for greater fiscal and political autonomy in Lombardy and Veneto and serious unresolved issues in the banking sector.

Monte dei Paschi di Siena may still be alive as a bank, but it’s not out of the woods. Last week its stock resumed trading after ten months of being suspended from Italy’s benchmark index, the FTSE MBE. Shares opened on Wednesday at €4.10, then rose 28% to €5.26. But it didn’t stick. On Friday, shares closed at €4.58.

It’s a far cry from the €6.49 a share the Italian government paid in August when it injected €3.85 billion into the bank to keep it alive. It spent another €1.5 billion shielding some of the bank’s junior bondholders, whose debt was converted into equity. As part of the rescue, the Tuscan bank was forced to present a plan to cut 5,500 jobs and close 600 branches until 2021, in addition to transferring 28,600 million euros in unproductive loans and divesting non-strategic assets. Investors clearly have their doubts.

In Veneto the situation is, if anything, even bleaker as over 40,000 businesses have been left starved of credit following the impromptu resolution of the region’s two biggest banks, Popolare di Vicenza and Veneto Banca. Bloomberg:

While Intesa Sanpaolo SpA, Italy’s second-largest bank, paid a symbolic sum to acquire the healthiest parts of the two Veneto lenders, the state entity that’s absorbing the 18 billion euros ($21.3 billion) of troubled debt the banks amassed, called SGA, isn’t fully operational yet. That has left small and midsized companies in the lurch—in many cases unable to do business.

“Many of these borrowers are profitable companies, but they’re stuck in limbo,” said Mauro Rocchesso, head of Fidi Impresa e Turismo Veneto, a financial firm that provides collateral to companies seeking lines of credit. “They don’t have a counterparty anymore and can’t find fresh capital from a new lender because of their exposure to the two Veneto banks.”

It’s not just businesses and investors that are losing faith in Italy’s financial sector; so too is the public. Just 16% of Italians still have confidence in the country’s lenders, according to a poll by the SWG research group of Trieste on Friday.

Trust in the Bank of Italy is also in decline, having plunged from 36% in June to 24% in October. Such widespread public mistrust didn’t stop the national central bank from awarding the bank’s governor, Ignazio Visco, another six-year term after presiding over the worst banking crisis of a generation.

The Bank of Italy’s reputation was further dented this month after documents presented in a Milan court case revealed that Italy’s central bank knew that MPS’ management had papered over a loss of almost $500 million in 2010 and failed to report it. At the time the governor of the Bank of Italy was Mario Draghi.

Now, as chairman of the ECB, Draghi is in charge of withdrawing the QE monetary punch bowl upon which many peripheral EU economies have grown dependent to keep servicing their debts.

Saddled with one of the biggest public debt mountains on the planet, Italy is particularly vulnerable to this change in policy. Even after three years of QE, Italy’s economy is growing at a rate of 1.5% a year — good for Italy, but still the worst in Europe. Once the the ECB stops snapping up Italian debt over the coming years, the southern European nation will almost certainly struggle to find buyers for its government bonds.

The ECB has purchased €300 billion ($353 billion) of Italian bonds under its QE program, which is more than three times the net bond issuance for the country during that period, according to Christian Schulz, European economist at Citigroup. That means the ECB has not only bought pretty much all new bonds issued in Italy since 2015, but also existing bonds from other investors.

As the ECB cuts its purchases by roughly half in two months’ time, those investors, including foreigners, Italian households and Italian retail investors, will have to come back into the market in a big way; otherwise the yields on Italian bonds will begin soaring, driving up the costs of funding for the government.

Once the ECB stops buying Italian bonds altogether, the only way for the game to continue is — according to research by Alleston Capital — if over the following six years non-banks increase their purchase activity up to seven times that of the past nine years. But these are the very investors who, via QE, were eager to offload the risks of Italian liabilities onto the Bank of Italy, and then onto the Eurosystem.

It’s a long shot, to put it mildly.

But Luca Cazzulani, deputy head of fixed-income strategy at UniCredit in Milan, doesn’t seem unduly fazed. “Because there has been a net transfer of bonds from private investors to the ECB, it must mean that the private investors now own less compared to before the QE program started,” he said. “There should be room for these other types of investors to step back to sort of restore what they originally had.” Now that is what you call wishful thinking. By Don Quijones.

This is “testimony to the iron grip the financial industry’s lobby still exerts on governments and legislators.” Read… The EU Just Did the Big Banks a Massive Favor

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  42 comments for “Financial Storm Clouds Gather Over Italy

  1. George McDuffee says:

    RE: … That has left small and midsized companies in the lurch—in many cases unable to do business.
    This shows yet again the danger of using “debt” for working capital in any business, as this puts the company at the mercy of the credit markets.

    When the commercial paper/money market funds seized up in the last credit spasm, it rendered even the largest corporations, such as GE, which were using borrowed money for working capital, insolvent.

    If a corporation can lend their working capital out at a higher interest rate than they can borrow the required funds, it can give the illusion of “profit,” but this entails huge risks [literally betting the company], particularly if they have lent the money long (term) and have borrowed short (term), which is always a temptation because of the difference in interest rates.

    FWIW: elimination of the deductability of interest as a business expense should help reduce this egregious bit of financial engineering and legerdemain, as would the prohibiting of using borrowed money for paying dividends and/or stock buybacks

    • Ed says:

      I think the U.S. used not to allow the buyback of stock, viewing it as manipulative. (And it is, I’d say. Managers can use company cash flow to buy back stock and effectively give themselves a big bonus.)

      This and the encouragement of funding-through-debt that you mention are destructive to the American economy.

      Ask an economist what “tax reform” would look like and they’d talk about these items you mention. They would also, I think, almost all support a lower corporate rate, but in the main fund the lower corporate rate through removal of corporate tax loopholes (for real, not just talk!) and a tax on the owners of the stock of those same corporations.

      There would be value in aligning the tax code with the interests of the economy. You might keep some benefits for the productive portion of the economy — manufacturing and R&D. But not banks and the service sector, in general, I’d say.

      • chip javert says:

        One problem with not allowing buybacks is (especially but not exclusively) tech companies use stock grants in lieu of salary. buybacks, allowing company to prevent retail shareholder dilution.

        • Kraig says:

          That’s an easy fix, buy out the stock grants prior to the grant since no stock is brought back, it won’t have the same economic result apart from on the employees etc who have helped by making the company.

    • Joan of Arc says:

      ” October the government was able to sell €2.5 billion of 10-year debt at auction at a yield of 1.86%, the lowest since last December…”

      Italy’s 10 year is selling for more than the US’s 10 year. That can happen when the ECB buys up all the debt. Heck, they could drive Italy’s 10 year to zero if they wanted to.

  2. Gershon says:

    Now, as chairman of the ECB, Draghi is in charge of withdrawing the QE monetary punch bowl upon which many peripheral EU economies have grown dependent to keep servicing their debts.

    Saying you’re going to withdraw the punchbowl and actually following through to any significant degree are two very different things. As I’ve noted a time or two, there’s no such thing as tapering a Ponzi.

    • Joan of Arc says:

      What would Leonardo da Vinci or Mr. Fibonacci have thought about all of this QE?

      • d says:

        “What would Leonardo da Vinci or Mr. Fibonacci have thought about all of this QE?”

        Davinci would have thought for a long time, before deciding, bad, as he was a multi disciplined Scientist, and Artist.

        Fibonacci, being a single discipline man, whose mind was faster than many of the current computers ,would have seen where it was going, and had a heart attack.

  3. RepubAnon says:

    It’s also the problem with making everything a “profit center.” If finance is a profit center, they want to find ways to generate a “profit.” This means everything from slow-paying vendors to entering into risky financial engineering schemes.

  4. Bobber says:

    The central banks appear to be tapering (EU) and tightening (US) to reduce systematic risks. We may see a well-deserved market drop in stocks and bonds over the next few months as the market realizes this. This drop would be good for the long-term health of the markets, as it would prevent a larger catastrophe later.

    If the central banks reverse the tapering/tightening programs at this point, faith in fiat currencies will be completely lost. It’s a good time to hold cash equivalents.

    The next six months are the real test. My bet is they continue tapering/tightening until there is a large enough market drop to cause a recession. Even then, they may just delay the program, rather than reduce rates again.

    As for Italy, any citizen holding Italian debt must be a speculator or have a boat load of money to lose. Any serious investor would have sold a long-time ago.

    • CV5 says:

      “The central banks appear to be tapering (EU) and tightening (US) to reduce systematic risks.”

      They don’t want to….they have to. And having to is scaring them to death just the same. I figure they are out of parlor tricks so time to drop the curtain.

      • Joan of Arc says:

        They don’t ever have to do stop QE. I don’t know why they want to.

    • Joan of Arc says:

      Didn’t Italy give us spaghetti and spaghetti westerns? What more do you want from them? Well, there was Marco Polo too.

  5. Realist says:

    If I’ve understood Italy correctly, the biggest problem they do have is that the Italians chose a line of action decades ago that means today Italy is competing with China in low tech stuff but with Italian wages. Small and middle sized business in Italy can’t compete with Chinese and other Far East companies. Italian design and workmanship is excellent at best, but designed in Italy can be manufactured at a much lower cost in the Far East….

    There are great and competitive companies in Italy, but those are too few. Machinery, fine mechanics, weapons, engines, sports cars, aerospace, such stuff are the Italians very good at, but they haven’t enough of these companies.

    FIAT is a particular problem, expert at building small, affordable (and low profit) cars but less stellar in building cars that generate higher profits … and in Europe the small car market has been under a lot of pressure since the crisis struck while FIAT’s American adventure, Chrysler, has turned out to be interesting indeed…..

    Another big Italian problem is the north/south divide, the rich, industrialized north, the poor mainly agrarian south ( if you forget different projects that usually have ended in failure similar to Mussolini’s recolonization attempts during the 30s of the countryside….)

    A third problem is Italy’s quite dysfunctional political system that makes any implementation of needed reforms more or less impossible.

    Then you have to remember, Italy has got quite hefty defence forces, their navy has 2 carriers among other things ( France has one, the UK one plus another under way, but no aircraft for them, btw ).

    And Italian wines and the Italian kitchen are great :)

    • Paulo says:

      I have an Italian-made small tractor. (BCS) They are designed to service small land holdings such as truck gardens, vinyards, etc. They are also reputed to be the best in the world, and after extensive research I bought one 13 years ago. The transmission has a lifetime warranty, and sports 3 gears forward and two in reverse with PTO for all implements. I usually use just the tiller and sickle mower, but I also run a few other attachments.

      The rest of the market ‘out there’ are poor imitations or Chinese knockoffs.

      I would guess a lot of disdain is shown Italians and their economy as a result of WW2, and their more recent haywire coalition Governments. Certainly, Berlusconi looked pretty bad, but compared to the current US dysfunction they seem pretty tame and efficient. :-)

      They should be able to coast on the Renaissance for a few more centuries, imho.

      (And no, I’m not Italian….)

      • Markar says:

        Before the Euro, the Italian economy was more productive than Germany’s, despite the endemic corruption that has plagued the country for generations. Left free of financial chicanery, the Italians always did and still do design and manufacture beautiful things, be it objects d’art, clothing or sports cars.

        • Joan of Arc says:

          The main black mark on Italy is that Julius Caesar couldn’t see it coming when 27 Roman Senators walked into the room with a total of 27 daggers hanging from their belts.

  6. Drango says:

    The fact that Draghi conveniently forgot about a half billion dollar loss while he was with the Bank of Italy is probably because to a central banker, that’s just chump change.

  7. walter map says:

    One could get the feeling the cosa nostra decided to go legit and went into banking and public service. After all, if one is to pursue a life of crime, it only makes sense to cut the penny-ante crap and go for the big time.

    It would tend to explain a few things, now wouldn’t it?

    • Jack says:

      Walter, from what I heard in Italy it’s rumoured that the insurance industry is mafia-run. I couldn’t believe how expensive it is, car insurance starts at €1000 euros for 3rd party, fire and theft for an old banger. No wonder ex-pats drive illegally in foreign-registered cars and insure them in their home countries.

  8. Rates says:

    My prediction still stands: a year from now, a similar article will appear and Italy will still be … just as it is today.

    • van_down_by_river says:

      A wise prediction – if you made the same prediction each of the last 8 years your track record would be perfect.

      We’re supposed to pretend central banks are going to stop monetizing government debt and deficits (no really they mean it this time!) without causing a fiscal crisis. This while the U.S. is trying to add to the deficit with tax cuts and increased military spending. It’s hard to take this game serious anymore – so I don’t.

      Sometimes the obvious answer is correct. All debts will be made null and void by inflationary default and we start again with new currencies. The only losers will be savers and wage earners and honestly bankers and politicians don’t give a damn.

      • chip javert says:


        You act shocked.

        You didn’t really believe debts would be paid back with the same purchasing power with which they were taken out?

        Just for reference: $23 of 2017 money was worth $1 in 1917 (if you thought it can’t happen here, it already has).

  9. raxadian says:

    What is most likely to happen when Italy enters default?

    And yes is gonna be a “when” not an “if” because I do not see any miracles.

    • Markar says:

      If or when Italy technically defaults, they’ll have lots of company. I think it’s called cascading CDO.

    • chip javert says:


      I have a one-word answer for you: Greece

  10. d says:

    Club-Med banking is like a child’s banjo, with heavily over-tightened nylon strings.

    Its when, not if, they break.

    So the question remains. Is the Eur north, sufficiently insulated from the coming Southern Banking, and State debt, Implosion.

    A large reduction in Eur price (it has no Value) is to the advantage of the Eur north. The north will probably keep the Eur around for that reason alone.

    There is no way the north will allow its taxpayers to be made liable for southern debts again.Thats what the bail in regulations were all about.

    After the southern defaults, there may be some movement on closer “Fiscal union” on northern terms, which the South will be force to simply concede.

    The Message north to south is simple, reform your banking and state fiscal situation, or eventually, we will let you implode. Just like greece, and to some extent, Cyprus.

    • van_down_by_river says:

      There is one, and only one, solution: pay back government debt with worthless confetti currency. The only unknown is the timing of the solution.

      The longer the game goes on, the more Euros speculators can borrow to buy up hard assets and pay back with confetti – I expect they will own everything when the dust settles.

      I know how the Germans reacted the last time this solution was implemented – wonder how they will react this time.

    • Haus-targaryen says:

      I respectfully disagree.

      While I cannot speak for the Dutch the fins or the Austrians, I can promise you the German government will back up all club med debt via the German taxpayer.

      Mutti will get on TV over here and talk about Germany’s historic obligation and how we’ve benefited from the EUR (an objectively egregious lie) and how out fellow Europeans need our assistance blah blah blah.

      The Bund will step in and crush any bond crusaders and that will be the end.

      “For a split second 10,000 Italian sovereign bond shorts cried out in pain … And then there was silence”

      The Germans will be the last one to go down with the ship. This country is run like a hippy colony and will implode in a spectacular fashion.

    • Crysangle says:

      Though much southern sovereign debt has been returned to origin or sits with the ECB ( hence mutualized) , the Target2 balance alone shows the level of outstanding investment south – that is debt to Germany in real accounting. If Euro implodes that is one big financial/currency mess for Germany, plus access to southern markets closed. Germany has no real option but to follow through with further mutualisation. I say option, in reality the game is geared into turning German industrial and financial advantage into political and business influence across the zone. Germany is clearly positioning for influence within EU institutions also. Now whether this can add up to, be watered-down into, something workable at European level , is a guess. I agree with the above reply though, that Germany is not headed out ( short of a wider break-up) , and that it might as easily implode with the whole of EU… which if you think about, might be the end game for the following creation of EU as one nation. The thought should make people shiver a bit. I actually think that the real aim is full centralised technical and financial control , a la social(ist) … but the EU forum is so corrupt, opaque and dull it is no replacement for the lively national and international politics we once had, so even its success would be a failure , not that I imagine it will get that far. Who knows really, a guaranteed world of uncertainty.

      • d says:

        “I actually think that the real aim is full centralised technical and financial control , a la social(ist)”

        The original intent was a liberal Eu Superstate.

        Brussels has become a Totalitarian Leftist monster.

        Bent on a Totalitarian Leftist Eu Dictatorship, centered in Brussels. At any cost.

        Show me a Totalitarian Leftist dictatorship, that is not obviously corrupt and I will show you that one has huge hidden corruption.

        Currency union with out Fiscal union is an unworkable insanity.

        Brussels knew this as it has been proven in Europe before.

        So why did they do it?

        “The warring tribes of Europe will never unite unless forced to”

        One of the major Fathers of the Euro and I believe Eu.

        “and that it might as easily implode with the whole of EU… which if you think about, might be the end game for the following creation of EU as one nation.”

        An Implosion was (possibly)not part of the plan but the Euro was always intended, as a weapon, to drive the tribes into 1. Anybody who denies that is a fool, or brainless.

        2008 rally upset their apple cart.

        The dictators in Brussels did not understand (or more likely did not want to hear) they needed to step back and wait for another “Fiscal Summer”. Before moving further forward with the BIG Fiscal and ever closer union shoves.

        Now we have a growing ANTI BRUSSELS movement, on the street, in many Eu nations. A Major budgetary contributor is on the way out of the Eu door. Which will negatively effect it, the EU, and the whole planetary trade, so Global Economic environment.

        Very bad timing.

        Yet Brussels still will not back off.

        There are to many BIG variables at the moment to make a long term predictions that can be acted on.

        Which is one of the major things, contributing to this long running (real Economy (not asset economy)) Stagnation.

        There are a group of things that will happen, at some point.

        Predicting the order, predicts the outcome, as the order continuously changes, so does the outcome.

        Which is why many of the big traders and groups, Buffet, Soros, Blackstone, Etc are hugely in Cash, they are picking opportunity as it present. Even they are having long term plan issues.

        Part of the reason the QE cash, cant find work, is that there is to much uncertainty. Everywhere there should be stability.

        Much of this uncertainty has been deliberately created. By several unpleasant and opaque, self interested nations.

        The continuous Drip drip of Stolen “Tax Haven” information is an excellent example. Of how much of this instability is being sown.

        Who gains, tells you who does, even though it cant be proven, as who does, has the state tools, time, money, and inclination to look, with almost plausible deniability.

        Just like the “Destabilisation” in the 2016 election, the winner of that destabilisation was not American. They may have overplayed their had in that, as now people are starting to look and a lot of other pieces are starting to fall into place.

        In the latest “Paradisae papers” Drip Drip, another senior member of the p 45 team got hit with a Russian connection. How convenient, for so many, who wish to see more Instability, in the US. And the free west in Generall. Off course if it is ever proven “who”, they will turn out to be “Patriotic citizens”. Again.

        • Crysangle says:

          I have the impression often that the uncertainty is purposeful. I mean that in the speculative sense, that for example 2008 was visible to the untrained eye ( I live in southern Europe and the apex in property valuation was well visible, as well as the local economy stalling as consequence, well before the bust, in spite of historically low rates at the time – Spain, in this case, was living a parallel to the US) and so MUST have been known by the ECB.

          You know once countries cycle out they now have to then turn to the ECB, EU. That leaves them debilitated, to the benefit of ( northern ) cash holders and policy makers. So either it is reckless corrupt monetary policy or purposeful boom bust, or both. Much of southern Europe had low private debt, or a public debt that was manageable, also in a political context, by devaluation.

          Now the ECB has consumed a vast portion of chosen European assets, at high prices/low rates, so filling the pockets of some for the next phase of tightening. What happens there? I suppose it might be money flowing out of junk into the sovereign market as the economy becomes more difficult and relative safety is sought, even as yields rise. Those in cash might look to pick up resulting bargains, who knows… I am not an investor, maybe it shows :-) .

          The point is though that the general direction is managed on a wider level, with room for political manipulation, as well as in allowing the more connected/chosen to profit or empower themselves in their local setting, in coordination with the overall EU policy which will be dominating the combined result.

          Where you blame opaque nations, I think you might be talking of southern countries . Just think though – they did not set the rates low, they are countries that feasted on easy money where responsibility was not in their hands for rates ..they acted as they have always done, the ECB at least would have been fully aware of this. What happens when you build an economy on easy credit, where you run out of buyers for its product ( housing)? You create a lot of debtors, a creditor who deserves to go bust , and a lot of confused argumentative unhappy people all round. That becomes a government financial burden, that then becomes a centrally ( EU and ECB) empowering, as it is a problem only they have the facility ( money hence policy) to manage….if they are up to it and member nations can ( or are fooled or ‘forced’ to) agree.

          Plenty of resistance around now to it all also, so I suppose we will see how it all does or doesn’t come together as they tighten everything in.

        • d says:

          “Where you blame opaque nations, I think you might be talking of southern countries .”

          Further afield than that, some with very large central command economies, That claim to be “Market economies”.
          “so I suppose we will see how it all does or doesn’t come together as they tighten everything in.”

          With the dirty little Mafosi at the helm of the ECB that tighten in real terms is far far away. His first concern, is Italy. Not the EU, always has been. He is I believe, still in the ring for another term.,

          Remember the ECB does “private ” bond purchases, that are not announced, until much later.

      • Cynic says:

        The EU is now representative of a sclerotic Legitimism, rather like the Powers which set about stamping out republicanism after Napoleon, and defending absolute monarchy -hence the refusal to consider secession by Catalonia, etc, even when such new states would wish to be part of the EU.

        Still, dead dodos of the political kind can stay upright for a fair while until they topple. Taxidermy…..

  11. John Doyle says:

    This whole mess is entirely due to the Eurozone creation and the consequent loss of monetary sovereignty. Before the EU event Italy had the highest savings in the zone. The unawareness of the consequences of not being able to command the country’s finances as the lira disappeared is probably due to the idea that Europe would be more united and stable after centuries of conflict. However the designers of the treaties deliberately used Neo-liberal themes and have created a total disaster. Sooner it is rescinded the better. Already it only survives because the central bureaucracy ignores the rules. Italy will be forced in the meantime to dishonour the debt or force the EU authority to create the payments, which is a problem as they are not supposed to do that. And not just Italy.

    • Crysangle says:

      Fully agree there, the Euro and Eurozone are THE mistake , a complete financial and political swipe at the continent.

    • raxadian says:

      Is more the euro currency that the eurozone itself. If most of the eurozone countries still had their own currencies then they could still use the old bitter remedy of printing money and currency devaluation.

      • Cynic says:

        The very wealthy love the stability of the Euro, they won’t change and if that’s bad for those in the lower tiers, they don’t give a damn -although they should, because everything has consequences……

  12. walter map says:

    “Financial Storm Clouds Gather Over Italy”

    There’s a lot of that going around:

    Turkey’s currency bubble pops

  13. a.hall says:

    The Italian Banks will soon be well Greased. Silvio Berlusconi is winning Elections in his Patron`s Sicily. Before he went to Jail he had a Mafiosi Bodyguard and a Vatican Bank Account. The Bankers will soon be getting invitations to “Bunga Bunga Parties”.

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