Risk of contagion in Italy and far beyond would be huge.

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

Just how low can Italian bank shares go? That’s the question plaguing the minds of European investors, policy makers, bankers and central bankers. Today the shares of the country’s third largest publicly traded bank, Monte Dei Paschi, plunged 14% to €0.33, their lowest point ever. Two years ago, they ran between €5 and €9.

The reason for the latest plunge was news that the ECB had sent the bank a letter urging it to draw up a plan for tackling its bad-loan burden. The lender is being asked to reduce its load of curdled debt by €10 billion to €14.6 billion by 2018. That’s a big ask even in the best of times, and these are certainly not the best of times for Monte Dei Paschi. According to Bloomberg, its loan loss provisions would represent over 95% of its operating profits.

No bank in Europe has fallen so low, so fast, without completely crashing and burning. On the eve of the global financial crisis, Monte Dei Paschi was worth €15 billion. Now its market cap is just over €1 billion. The only reason it’s still alive today are the multiple taxpayer-funded bailouts it has received, and all they seem to have achieved is to postpone the inevitable (and prolong the taxpayers’ suffering).

Earlier this year, Italy’s government was given the go-ahead to set up a bad bank in which to bury some of Italy’s most toxic financial waste. It was a €5 billion solution to a €360 billion problem, as we warned at the time – far too little, far too late. Last week the EU, in a fit of desperation, authorized the country to use “government guarantees” to create a “precautionary liquidity support program for their banks.” But given that the guarantees are not supposed to be used and do nothing to address the bank’s biggest problem — gaping capital holes — the stunt was pure political theater.

Lo and behold, just four days later, investor fears are once again spiking. This time around, however, Italy won’t be allowed to use taxpayer funds to bail out the bank, thanks to Europe’s new rules that require that stockholders and some bondholders get bailed in first.

“We wrote the rules for the credit system, we cannot change them every two years,” Angela Merkel said last week.

Whether Merkel holds firm to her commitment is a matter of debate. Given that the rest of Italy’s big banks, including its one and only global systemically important financial institution, Unicredit, are in similar straits to Monte Dei Paschi and Italy’s government boasts the third biggest public debt pile in the world (after the U.S. and Japan), there is a very real risk that the country could end up suffering a bank run, if not an outright banking collapse.









A subsequent bail-in would decimate Italian retail investors, who own roughly a third of Italian banks’ debt, just months before Italy’s Premier Matteo Renzi faces a make-or-break national referendum on constitutional reform, in October. As Hedge Fund manager George Soros warns, Italy faces the risk of a “full-blown banking crisis” that could bring the rebel Five Star Movement to power as early as next year. That is the last thing either Brussels or Rome wants.

Hence the gathering rumors that Renzi is considering taking matters into his own hands and enacting a unilateral sovereign rescue of the Italian banking system in defiance of the EU. Ambrose Evans-Pritchard writes in The Telegraph: those who know Renzi say “he will not go down in flames for the sake of European ideological purity.”

It’s not the first time Renzi has ruffled Brussels’ feathers. A couple of years ago he defied the Troika of creditor institutions by warning that their technocrats would never be welcome in Rome. Now he seemingly thinks (and he could well be right) that he holds a much stronger bargaining position than might first appear, thanks primarily to the ever-present danger of crisis contagion in the Eurozone.

As the EU’s third largest economy, Italy’s weak economic performance — the country has barely grown this century — is as much of a headache for Brussels as it is for Rome. With €2.23 trillion of public debt, €400 billion of which is festering on Italian banks’ balance sheets, Italy is not only too big to fail, it’s too big to save.

If a bank the size of Monte Dei Paschi were to fail, the risk of contagion, first within Italy’s borders and shortly after far beyond them, would be huge. That is why policy makers in Europe are now frantically looking for a loophole in the new legislation that would allow them to subvert the same bail-in rule that they themselves created. According to Reuters, they may well have found one:

The rules, which have been in force since January, allow a state to directly acquire a stake in a bank that fails a stress test and cannot raise capital in the markets because of “a serious disturbance” in the domestic economy.

If Europe’s leaders opt for this ruse, the message to all other Eurozone nations will be loud and clear: when things get serious, Europe’s financial rules can — indeed, in some cases must — be bent or broken. The result will be to render the bail-in rule null and void even before it’s been properly used. That’s not to mention the PR nightmare of raiding European taxpayers once again to save a bankrupt financial system. By Don Quijones, Raging Bull-Shit .

So for how long can this elaborate confidence game be maintained? Read… As Fears of “Bank Run” Escalate, Italian Banks Get €150 Billion Bailout of Empty Promises









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