Europe’s southern periphery bonds were gaining ground relative to German on Monday, not least Italy’s.
The President of the European Central Bank, Mario Draghi, confirmed on Monday that a prolonged period of cheap liquidity is necessary. In his opening statement to the European Parliament, Draghi made clear that the Eurozone’s (lack of) recovery is progressing at “a moderate pace, supported mainly by out monetary policy measures.” Therefore, yield-hungry industries like insurance companies and pension funds flocked bonds that provided higher yields, with a reasonable risk.
The ECB is buying government debt from peripheral Member States and will keep doing so, reducing the risk for institutional investors. This is necessary for Italy – the Eurozone’s third-largest economy – that is experiencing a banking crisis.
On the third week of January there was a “run” on Italy’s third largest bank. The panic was Athens-like. Depositors withdrew their money from Banka Monte dei Paschi de Siena SpA (BMPS). The bank’s CEO, Fabrizio Viola, described the outflow as “limited.” The day after Finance Minister, Pier Carlo Padoan, stepped in to suggest the bank still had “strong fundamentals and large liquidity,” before Renzi took over to appease the general public.
The panic then was triggered by a rumor that the ECB was asking three banks BMPS, Banco Popolare and UniCredit for data triggered the panic. And there was a reason to panic as bail-ins hit four small regional Italian banks in December.
no way forward
As the panic resided, the losses for the sector’s valuation is a modest 24%. The reasons for the crises are shared across Europe. According to Banking Association data released in November, Non-Performing Loans (NPLs) have reached a mountain of €201bn, comparable to the Greek GDP. And that numbers makes a number of analysts smirk; it seems too modest.
To say that recession is not likely to increase confidence in the Italian economy is an understatement. Unlike Ireland, Greece, Spain, or Portugal, the biggest worry in Italy is not mortgages. The International Monetary Fund reports that 80% of the NPLs are corporate loans. If these corporations go down, the Italian economy goes down. If the loans are written off, the lenders’ bottom line will look even worse than now; they will need recapitalization of the kind that the stock market will not provide. Everyone’s looking at the taxpayer.
So, what can the tax payer do? Not much is the answer. Deleveraging, creating a bad bank, and recapitalizing would require Italy to borrow immensely, over and beyond its 132,8% debt-to-GDP ratio. That is why that idea of a bad bank is treated cautiously by the European Central Bank.
Super Mario steps in
Another idea is to monetize Italian bad loans. For the moment, this is considered illegal. As pointed out by Monetary Watch, ECB rules, prohibit Frankfurt from buying disputed loans. But, in a “whatever it takes spirit,” Mario Draghi hinted on Monday that NPLs could potentially be used as collateral for Italian banks to borrow. After all, such assets can’t be worse the Greek government bonds.
That kind of monetization is what the Italian government is counting on, according to Reuters. For the moment, the woes of the banking sector have not undermined Italy as a sovereign debtor, with the country borrowing at 1.56% in January, which rose to 1,62% as of recent. That is much lower than the 7.5% in November 2011. For the moment, Italy’s BBB- just-about investment grade rating is essential, not least an important part of this ECB scheme is to have Rome “guarantee” NPLs, with everybody knowing that is a promise that cannot be met. Italy does not have the money and does not have the fiscal space to make such promises. But, this is a lie one can agree to believe if it serves a purpose.
The only other way to avoid collapse is to follow Spanish 2012 recipe. Now, if one were German, or Greek and Irish, this discussion might seem a bit unfair. The looming Deutsche Bank crisis may widen the consensus for that kind of monetization of the banking problem in Europe, but we are not there yet. Italy can’t borrow to fix the problem and cannot afford to have its banks – and their bad assets – simply liquidated. In effect, this is not a matter of fairness but of choice.
This is a Greek dilemma in which a Greek solution is not possible. Too many banks have bought Italian sovereign debt. Given the current multiple-crises, many in Frankfurt, Rome, and Brussels would like this problem to go to sleep for some time. And here’s the rub; for in that sleep of death what dreams may come.