Italy Bank Crisis Looming With Rush to Rescue #3 Bank, Monte dei Paschi

The European tendency to wait until the last minute may prove to be too late.

The Financial Times warns today that the big Italian bank domino that observers have been watching most closely, Monte dei Paschi di Siena, will go critical this Friday if (more likely when) it fails the bank stress test. The non-trival problem is that implosion would be so large as to exhaust what is left of Italy’s rescue funds. Yet the ECB and European competition authorities have so far refused to give Italy a waiver under the new banking rules so that it can avoid subjecting small savers who were duped into buying bank bonds to bail-ins. Prime Minister Renzi has had a good bank/bad bank resolution plan ready to go since early this year, but using state funds to support such an approach as an alternative to bail-ins is verboten under the news rules.

So how are the Italians proposing to finesse this mess? A “private sector rescue”. That means having the less sick banks prop up the really diseased Monte dei Paschi. The net effect is to increase systemic risk, since it knits the banks together even more than before. We saw a variant of that in the US financial crisis, when bank regulators had the barmy idea of encouraging banks to buy other banks’ subordinated instruments, creating a major impediment to resolving mid and larger sized banks, since wiping out those instruments would produce losses at other banks, potentially a cascade of failures.

However, the healthier banks have nixed a straight-up equity purchase. As you’ll see, the latest plan looks unworkable, since it calls for more fresh capital via a rights issue. And who pray tell will stump up for that?

From the Financial Times:

Italy was last night racing to secure a privately backed bailout of Monte dei Paschi di Siena, the most exposed of the country’s troubled lenders, including a plan to raise €5bn of fresh capital so as to avert nationalisation, according to bankers and European officials….

People directly involved in the Monte Paschi discussions say they are aiming for a private rescue of the bank to be announced before the stress test results are published after US markets close on Friday.

But they admit that the negotiations could go down to the wire or run into or beyond the weekend. This raises the prospect of shares in Monte Paschi and other Italian banks coming under renewed pressure when markets reopen on Monday, which many fear could prove lethal.

Any such rescue would be under EU rules, which would mean a so-called bail-in, where junior Monte Paschi bonds would be converted to shares, and compensation given to retail investors…

The privately backed plan, which is still under discussion and could change, would involve a multi-layered deal to rid Monte Paschi of €10bn of net non-performing loans and recapitalisation worth up to €5bn, say people involved in the talks….

Instead, Intesa Sanpaolo and UniCredit have agreed to put an additional €160m into Atlante, a privately backed fund, alongside pension funds and CDP, the state bank, to put a total of about €3bn into Monte Paschi bad loans.

To clean up the lender, at least €10bn of its NPLs would be spun off into a special purpose vehicle. This would then be securitised, with shareholders taking the more risky junior tranche of debt and Atlante taking the mezzanine tranche.

The least-risky senior tranche would be backed up to €7bn of bridge loans from a pool of banks likely to include JPMorgan of the US and Mediobanca, the Italian investment bank. The longer term aim would be for the senior tranche to be guaranteed by a government-backed scheme, known by the acronym GACS.

To boost its capital, Monte Paschi would launch a rights issue of up to €5bn, its third in three years and worth more than five times its current market value. However, analysts believe this fund raising would be difficult given the bank’s reputation for scorching investors capital.

Mind you, Italian banks are full of bad loans. Italy was seeking authorization to use €40 billion in state funds to rescue its banks. An analyst cited in the Financial Times piece thinks it will take a mere €30 billion. Either way, even if the authorities manage to cobble together a scheme to keep Monte dei Paschi going, the bank failing its stress test would put even more pressure on Italian banks and Eurobanks seen as fragile, such as Deutsche Bank.

The plan in Italy seemed to be to try to hold the banking system together until the constitutional referendum in October. Renzi earlier said he’d resign if it failed but recently he’s tried retreating from that position. Commentators believe that if Italy were forced to resort to a bank bail-in, voters would take their revenge on Renzi in the polling booth. If his referendum failed, Renzi’s government may fall regardless. The pro-exit Five Star movement is the leading party in Italy right now, and it has promised it would have a referendum on leaving the Eurozone. So the political and economic stakes are extremely high.

The death watch over Monte dei Paschi has a Lehman-esqe feel. The powers that be were hoping they could hold off a financial crisis until after a key election, yet they were also deeply committed to not doing any bailouts. The Europeans may be about to learn that their “kick the can down the road” strategy has taken them to the brink of a precipice.

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  1. visitor

    So the bail-in scheme was known from the start to be technically no better than bail-out mechanisms when it comes to averting a cascading financial collapse, and to be politically dicey as well (as shown by the upset reaction of Cypriots at the very first EU bail-in plan for Cyprus banks).

    The inflexible bail-in rule excludes other ways to deal with a banking crisis, hence allowing as alternative only contorted constructions of the kind proposed by Renzi’s government to save MdPdS — which prove to be too wobbly for comfort.

    If a bail-in fails, then all hell may break loose, as there is no true banking union, no European-wide resolution mechanism, no fall-back mechanisms in place.

    There must have been an immensely compelling reason for EU governments to sign off on that obviously perverse design, but I just do not get it.

  2. Gee

    As far as I can tell, there is no way they can politically afford to have a bail-in that whacks Italians that were duped into buying “safe” bank bonds as a way to access credit. The story of Vicenza should give them sufficient fear that the proper course is to just say FU to the EU rules and do the bailout, rather than the bail-in. Screwing more Italians is a great way to get the Five Star Movement elected and end up with Italy’s version of an exit referendum. 60% of Italians want a referendum, and 40+% say they want to leave. Those numbers only go up further with a bail-in that wipes out more of people’s savings. Germany may not like it if Renzi stiffs them, but he cannot afford to lose the referendum vote on constitutional change, as he says if he does lose he will resign. If they lose Renzi, it can get very ugly. If they decide to not handle this properly by being pig-headed about the absurd rules they cobbled together, they can await the contagion to Deutchebank in Germany and see how that works for them.

  3. Gee

    Sorry, I somehow missed the last paragraphs which covered some of my points. I guess as one person put it, it’s easier to ask for forgiveness than permission, which points to just going against the EU rules and doing the bailout, and dealing with the consequences. They have been failing at the private investment solution for months now, so I doubt that is going to fly, and as I said, the bail-in looks like political suicide.

    1. Yves Smith Post author

      Have you ever dealt with programs like this? They don’t have any existing “program”. Will have to be set up. That will easily take months , probably a year, and that has nothing to do with it being government. I can tell you from dealing with private sector clients. They need to have forms so people can apply for compensation, they have to prove that they lost money and how much. The government needs to review the documents and have anti-fraud controls in place.

      So it’s over a year before they get their money back. And how do the live if they are retired or otherwise needed the money they lost? And then you have people whose paperwork is rejected and have to reapply…

    2. Clive

      When my TBTF sets up a unit to process customer redress (e.g. due to a court ruling, regulatory edict, financial ombudsman decision etc. etc. etc — there’s been so many this is a fairly regular occurrence) the project plan lasts 2+ years. Minimum. You have to design the system to handle the processing. So first, you have to define how the “proposition” to the customer is going to work — do you want them to submit written applications ? Or supplement with an online channel (online will reduce your costs, but a lower barrier to entry may not be what the TBTF wants as it increases customers registering for their payout) ? Do you have to offer telephone support — and is that a helpdesk/advice service or an execution/application channel too ?

      What volumes do you expect per day / month ? — you have to size the system and the operation team appropriately. And do you spend some time and money up front on automating the process (as best you can) or just have everything done manually ? If it is all manual processing, this increases the size — and the skills needed — of your operations team. And where do you site the people ? Big businesses do not simply have hundreds of seats of office space sitting there unused, just waiting.

      And this all presupposes you have the documentation in one place, nicely indexed and available. Not stuck on some tape offsited in a backup bunker which isn’t supported hardware anymore.

      Whenever anyone glibly suggests setting up some sort of operation of the scale required here and expects it to happen, just like that, it all has an air of “let’s just have the show right here in the park” about it. They’ve obviously never had to actually implement the sort of technical and people systems needed to deliver it.

      1. Dan

        Another thing to remember is that (from what I understand) Italian civil law does not allow agencies to create regulations or processes independently, but rather administrative rules have to be promulgated as laws. Besides that, public agencies use cash accounting systems and change _extremely_ slowly. For instance, it can take 5-10 years to simply create a new spending account within a ministry.

        A more subjective impression: when I lived in Italy, I ended up just using the postal bank after several attempts to open accounts with private banks (including Monte dei Paschi), which set very high hurdles in terms of paperwork, minimum balance, and fees, not to mention suspicious and almost hostile behavior by bank staff that one should want to do something strange like open a bank account with them. The attitude is that the customer should prove that they deserve to have an account with the bank, rather than the other way around. Given these issues it is hard to imagine Italian banks setting up user-friendly or effective means of reimbursing bailed-in savers. I’d guess it would take on the order of 10-15 years to plan, roll out, and implement such an idea.

      2. visitor

        Explain something to me. To set up those procedures,

        the project plan lasts 2+ years. Minimum.


        there’s been so many this is a fairly regular occurrence

        Those procedures re-occur so often, but there is no learning curve whatsoever which would have reduced the time to deal with them?

        No streamlining of the design process, based on accumulated experience? No relying upon existing structure and personnel, already versed in dealing with comparable issues? No SOP in place to direct the project and quickly fire up infrastructure and rapidly prune the choice tree?

        The more I read, the more I am convinced that those TBTF entities are just beyond hope and as the epitome of inefficiency, they should be dismantled.

        1. Clive

          No. Each situation is different. Sometimes you’ve mis-sold a regulated product (say a market linked investment account). This would have a small customer base needing redress, a few tens or hundreds of thousands, but impose a very high complexity / high touch response on the team and system you’ve brought in to implement the reimbursement.

          Conversely you may have a mass-market product which needs a bulk processing of an unlawful fee refund. Compared to the niche product I’ve given in the above example, is like comparing chalk and cheese. It’s outlandish to propose the same system and process designs can be re-used.

          As a concept “giving people back something you owe them” they are indeed the same. Everything else once you move away from the broad-brush concept is unique and bespoke.

          1. Clive

            And you’re also presupposing, perhaps unwisely, that large organizations keep their knowledge and their experienced staff together and accessible. The project I was working on only today (we had several rather tedious conference calls which droned on and and on, achieving very little, but such is my life alas) has eventually come to the reluctant conclusion — it’s only taken about a year for the penny to drop, I had the hunch from the first month or so — that a system / process / product design for which the solution was only put in maybe two or three years ago is now a complete unknown.

            Everyone on the original project team has left, been fired or has otherwise moved on. If anyone is remaining in the company that does know about it, they’re keeping very quiet (and they know they won’t get anything other than aggravation if they do ‘fess up to knowing how it hangs together / where the bodies are buried.) The documentation, if it was ever written, has gone AWOL.

            We’re faced with, if not reinventing, then certainly rediscovering the wheel. Your faith in the ability of big business to manage itself efficiently, effectively or even competently is rather touching. Brings a tear to my eye, it does.

            1. visitor

              Your faith in the ability of big business to manage itself efficiently, effectively or even competently is rather touching.

              Oh, I worked for big business and have a fair idea of how (in)efficiently and (in)competently things are being managed. In fact, the most catastrophic project I was involved in exhibited troubling similarities to the one you describe — and, surprise, it was overwhelmingly carried out by subcontractors.

              In general however, the products combining hardware+software sold to customers did require commitment to manage and keep track of certain things at least half-way competently.

              Requirement specs were far from perfect (in many cases very much so), design specs of uneven quality, detailed doc never 100% up-to-date — but information missing entirely? Could not happen — the entire product life-cycle revolved around documenting it.

              1. Clive

                Yes, I suspect the documentary assets were produced, as you rightly say, most places it is a do-or-die thing (almost!) but half a dozen organizational changes later, it’s fallen down the cracks somewhere. We should write a book on it all, someday…

      3. JustAnObserver


        The biggest one of these compensation requirements I can recall, at least in the UK, was the PPI mis-selling scandal that cost the UK commercial banks together many 10s of billions of pounds (*). What was the scale of operations needed for this at your TBTF ? Depending on how many Italians got stiffed with these bonds-just-as-good-as-cash (shades of the Auction Rate Securities fiasco) this might give a hint of the OPs size needed.

        (*) Its been said that the overall size of the compensation involved acted as a mini fiscal stimulus and probably kept the UK economy from totally tanking under Osborne’s neolib austerity regime.

        1. Clive

          Can’t say too much, but the cost of the administration for the redress (not the redress itself, which is accounted for separately) is north of £2bn and employs 5,000 people.

  4. Gee

    They did have to do some compensation on the last set of bank bail-ins, but I think it was rather on the insufficient side.

    Here’s the article I was referencing :

    What no one wants to talk about is how it came to be that these bonds were sold to retail buyers in the first place. From this story it looks like pay to play, which to me seems seriously f-ed up. That so many people thought it was a good idea makes me think that it was simple fraud. Im sure their lawyers can learn from ours in the US though, and show how it really seemed that these were safe at the time, yadayada.

    I’d say by Friday we will have reached the “exceptional circumstances” situation that Draghi said would make a bailout acceptable :

    Regarding compensation, it is on the table :

    “Brussels has hinted that the bank’s senior bondholders and depositors could be spared, and would not oppose the setting up of a compensation fund for smaller investors who were missold risky financial products.”

  5. Gee

    Yves brings up a good point – not only did they fail to do a good job of compensation in former attempts, if they did so this time around, the process would still be 1) we take all your money and you are poor 2) you apply through the typical Byzantine Italian bureaucratic systems to get some portion of your money back. 3) You wait in hunger and anger for many months, pondering why these types of people should be thrown out of of office, strung up from streetlamps, etc.

    They do not have time to do a compensation scheme, given that the referendum is in October. Hell, even if it were in October 2017, they would still be screwed. They cannot take any money from people that they scammed into buying those bonds. It’s crazy. I will be shocked, shocked if they do. Italy is turning into the EU powderkeg we’ve warned about for years, all through the sovereign debt crisis. You cannot go down that road.

    1. Uahsenaa

      But as we saw with Greece, the Germ–err, ECB always takes the line of “the rules are the rules.” I do wonder if the added political pressure of the possible breakup of the EU (Brexit, Catalonian separatists, now Italy…) will provide the necessary impetus to make someone see reason and for once damn the rules.

      1. PlutoniumKun

        Actually ‘the rules are the rules’ only applies to non-Germans. Germany has repeatedly broken ECB rules without consequence.

  6. babaganush

    Yes, stick it to the pension funds on the premise of civic duty to rescue the incompetent and reckless banks. And to avoid EU state aid rules. Apparently, pensions funds are being promised a “juicy” 6% return for the privilege….

    Back in the 90s during the banking crisis the Swedish government also raided the pension funds to the tune of ~SEK300bn – pretty sure those funds have not been returned.
    “The Association of Liberal Profession Pension Funds (ADEPP), which represents Italy’s casse di previdenza, has agreed to support a new fund to help rescue the country’s struggling banks.

    Atlante 2 will be created as a fund to invest in the banks’ bad loans, buying them at below book value but for more than would be paid by distressed debt specialists.

    “Oliveti [head of ADEPP] told the ANSA news agency: “We are aware it will not be the most profitable of investments, but, on behalf of our members, we are trying to protect against future country risks, which could cost us much more than we might lose through this investment.

    “There is now a great focus on the development of our country and its economic framework because it is from this our members derive their jobs, earnings and the expectation of a pension.”

    Italian pension funds were previously encouraged to invest in Fondo Atlante, a similar fund now backed by investors to the tune of €4bn, promising a 6% return.”

  7. John k

    Does merkel have a dtrong enough grip on power at this point to accept a bailout?
    And even if so, how long will it be before we all see that 40b is not enough to absorb 360b in losses?
    And can I take the over on that last number? That number has been growing rapidly, what is the long term plan given no or neg growth?

  8. Glen

    Is it just me or does the technocrats running the EU have some sort of death wish?

    Surely Bexit has demonstrated that a desperate public will take even bad moves to get change.

    What’s the current odds on the existence of the EU in five years?

  9. Gee

    it’s a tricky path for the EU/Schauble, etc. They are very worried about domino effects of bailouts, rule changes, EU exit votes etc. They have to appear strict, unforgiving, etc, until the very last moment of crisis, otherwise, people will play them. Greece really held no cards, so it could push that to the limit and just roll them in the end. Not so easy with Italy. The problem is that reducing economic contagion risk is coming at the price of increasing political risk as they strangle economies, reduce the social safety net, kill off a generations hopes and dreams, and fuel discontent with the EU and the euro. In the end, the silly thing is that they refuse to ever get their act together on a fiscal union, which is what really needs to be done. It’s all about avoiding the things they didnt want in the first place when the EU was created. They LIKED its flaws and want to keep them, because they (Germany) benefit from them. When you zoom out and take the long view, despite these little victories they think they are attaining, the whole thing appears to be unraveling. The rise of anti-EU parties, the continuing cratering of the banking system, a ride down the rabbits hole of negative rates and asset price dependent growth. Doomed. Doomed. Dooomed. (thank you Ingmar.)

  10. Jim Haygood

    ‘Fund raising would be difficult given the bank’s reputation for scorching investors capital.’

    No kidding. In 2014-2015, Monte Paschi did successive 1:100 and 1:20 reverse splits. So an investor who owned 2,000 shares of Monte Paschi in 2013 now has ONE share worth €0.29.

    Ten shares of Monte Paschi will buy you an espresso.

    Practically speaking, Monte Paschi’s penny shares are just an out of the money call option on a business with negative equity.

    Do ya feel lucky?

    1. Clive

      Japanese banks burned through their shareholders’ funds twice. Everyone said at the time, oh, how terrible, those Japanese, aren’t they just hopeless.

      Well, if I remember your previous comments on this rightly, Italian banks are now on the third passing round of the begging bowl.

    2. craazyboy

      What’s luck got to do with anything? Say you put half your money in a ZIRP savings and checking account. The other half in the zero risk bank bonds for a touch of interest. Your “idle cash” is bailed in and now converts to stock at the fire sale price of a third of a Euro. Most people don’t buy when blood is running in the streets – and that’s when the big opportunities are missed!

      Voila! As they say in Italy. You now have a portfolio half in stock and half in bonds – a good balance between growth and risk. Plus you can vote your proxy – participating in the management of your company. Next, we see your company needs to some raise some cash. Something about possible bad loans – but this is banking, isn’t it? Get used to it. It’s a cost of biz. The people with the money you need are probably gonna want something, right? That’s how it works. But the bank has assets! Just look at all that on the balance sheet! So you can sell some stock to the new money people. It just goes on like that. If not, you can declare bankruptcy, wiping out your stock but then you convert your bonds to stock so that’s almost like you can’t lose in the long run. Then you can sell new bonds in case you need cash for the bad loans. See? You can probably keep this going ’till Jesus comes home. That should be long enough.

  11. NoOne InParticular

    Forgive the elementary nature of this question but what are the consequences to Italy if it goes ahead and breaks the rules and bails out the banks?

    1. Clive

      That is a very god question so kudos for asking it, it’s an important point.

      Answer is:

      Same as the ECB did to the Greek banks — cut them off (or make it clear in either on- or off-the-record briefings they would be cut off) from Emergency Liquidity funding. Same trick they used on the Republic of Ireland. Remarkably effective, I’ll spare everyone the mafia jokes.

      1. JustAnObserver

        I think there may be a difference in the politics in the Italian case. For both Greece & Ireland there was no party waiting in the wings with an explicit goal of a Euro exit referendum as there is with Grillo’s 5-Star. Pulling EL funding would mean constitutional referendum fails => government falls => new elections bring in 5-Star => Euro referendum => ???. This threat would work for Renzi but only if he extends the middle finger to Germany/ECB and initiates the bailout now, starting with Monte del Paschi this weekend.

      2. visitor

        Is an outright nationalization of the bank explicitly excluded by EU rules or would it be considered as a disguised form of bail-out?

        1. Clive

          Yes, previous bank bail outs have been deemed — and treated as such by the Commission who insisted on the imposition of compensatory measures such as break ups and sell offs — as constituting state aid. But that was in 2007/8 and I think that post the GFC, the new regime was brought in to make it hard-to-impossible for governments to simply go straight to doing the state aid step without first having the bail in triggered.

    2. John

      I have an even more elementary question…why is it exactly that the EU changed the rules to prohibit bail-outs? Is it because they were afraid of the consequences publicly-funded bailouts would have for the sovereign debt crisis of the PIIGS (ie none of them have enough money for said bailouts but would get pressured into them by their domestic financial sectors)?

      1. Clive

        To be fair, the measure is designed to prevent governments giving subsidies to their domestic businesses which is anti competitive. So, to coin a phrase, their hearts are in the right places. But as the article points out correctly, this is all fine in theory but the consequences are simply awful.

        1. Jim Haygood

          It’s the same idée fixe as the fiscally righteous northern Europeans proposing to fine the incontinent Iberians for exceeding the Maastricht limit of 3 percent of GDP.

          These are post-Bubble economies, trying to keep their banks and social services afloat. Put them in an impossible box, and something has to give.

          Evidently the EU has a death wish. Post-Brexit, it is exhibiting the same inflexible behaviour toward its remaining members that prompted Brits to bail.

          DieselBoom: persona non grata in Capri and the Costa del Sol too. He probably prefers ice baths in the North Sea, anyhow — to build character and discipline.

    3. Yves Smith Post author

      That is a good question. We have a link in Links today about Spain and Portugal facing fines for breaking budget rules. This would defy not just budget rules but also the BRRD (new banking rules). So they could be fined. Could the head of Italy’s central bank be sanctioned? Maybe.

      The thing I need to check and have not had time is if the Italian banks are vulnerable to the ECB cutting them off. That punishment is far more effective than any other. But for Italy, it would be a nuclear weapon. It would kill the economy, which would be devastating to Europe, and would certainly blow back to other Eurobanks. So even if they could do it, I have a hard time thinking they would.

      1. JL

        When have the Eurocrats ever shied away from cutting off the nose to spite the face? I don’t think they’d even hesitate. After all, it worked before!

  12. Gee

    On a totally different note, I think the Trump for President campaign may have blown itself into oblivion today.

    1. Clive

      What, again?

      (on a more general note, it’s best to post comments unrelated to an article in the “Links” section or, when Lambert posts it “Water Cooler”. Even better if you give a bit more background and elucidate your point a tad. Especially for the benefit of us international readers who are slightly clues less about the in’s and out’s of US politics and might have missed the domestic news update being referenced.)

    2. Lambert Strether

      Epitomizes drive-by, one-liner, link-free, and no-value-add comment. Well, value-add to the extent that I went and found a likely link, and then added it to Water Cooler.

    3. Yves Smith Post author

      On what evidence? Hate to tell you, but the poll numbers are moving more and more in Trump’s favor. For the first time, he’s now ahead of Clinton in most polls. We’ll see how much the Dem convention ate into that next week.

  13. Sound of the Suburbs

    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?
    It’s too late.

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