Is an Italian Bailout Likely?

Italy is too big to fail for the euro but Germany has so far resisted a fiscal union
By Christopher Whalen
Christopher Whalen
Christopher Whalen
Christopher Whalen is the chairman of Whalen Global Advisors and the author of "Ford Men." This article was first published by the Institutional Risk Analyst.
June 4, 2018Updated: June 4, 2018

The financial stress in Italy is hardly new. The bad debts in the banking system have never gone away. A relatively stable government and massive money printing by the European Central Bank (ECB) has merely tapered over the issue. Now that an anti-EU government is in charge, the skeletons are coming out of the closet.

The ECB is trying to perform damage control among and between member states that still control bank supervision at the national level while at the same time paying lip service to improving the banks’ capital position.

There is no mechanism for supervising EU banks on a unified basis, nor any agreement on loss sharing or even a retail deposit insurance safety net. And the biggest obstacle to moving forward with these initiatives is the enormous public antipathy toward banks.

Accounting Gimmicks

In Italy, the government has managed to move significant amounts of bad loans off the books via securitizations with government guarantees on the senior tranches. “Huge volumes of Non-Performing-Loans (NPL) (€37 billion in 2016 and over €47 billion in 2017, according to consultancy Deloitte, have been sold by banks, often to specialist American hedge funds like Cerberus Capital Management or Fortress Investment,” the Economist reports. The European Commission has agreed that these securitizations of bad loans do not constitute state aid “as the guarantee will be priced at market levels.”

The latest official figure on bank NPLs from the Bank of Italy is 11 percent of total loans, an enormous figure but better than the mid-teens number reported in 2016. Banca Monte dei Paschi, for example, reported 14 percent NPLs at the end of Q1 ’18. By comparison, a bit over 1 percent of loans held by U.S. banks are currently marked as past due. The peak of U.S. NPLs was 5.5 percent in Q4 2009, when the U.S. banking industry charged off $60 billion in bad credits in a single quarter. Such an act of financial housecleaning is impossible in Europe.

To Bail or Not to Bail

As the M5S/Lega coalition engages with the other EU member states, they would do well to remember that the Germans ultimately are financing short-term borrowings via the ECB. Of note for investors in Italian banks, German Chancellor Angela Merkel rejects any debt forgiveness schemes for Italy – one of the early demands from the M5S/Lega government that was apparently dropped – at least for now.

Merkel stated flatly that solidarity among Euro area members should not lead to “a debt union” – a concept that would spell political suicide for Merkel and her coalition. Yet it is some measure of the dire situation in Europe that the German leader leaves open the possibility of a bailout for Italy.

French President Emmanuel Macron advocates the creation of a specific budget for the Euro area, with the appointment of a finance minister, and the transformation of the European Stability Mechanism (ESM) into a European Monetary Fund (EMF). Merkel apparently agrees.

“If the entire eurozone is in danger, the EMF must be able to provide long-term credit to help countries, Merkel said on June 2. “Such credits could be spread over 30 years and granted on the condition that the beneficiaries undertake structural reforms.”

The reality in Europe is that structural reforms never occur in large member states, only in the subordinate states such as Ireland, Greece and Spain. Italy, as Europe’s largest debtor state, lacks the political will to get its banks and fiscal situation in order. Thus, Merkel seems to be preparing the way for a bailout for Italy if for no other reason than to protect German banks. Think of it as a larger version of the Greek project.

The M5S/Lega coalition has explicitly threatened sovereign debt default, an explicit act of extortion focused on Germany and Angela Merkel. Is an EU bailout bullish for Italian banks? Maybe in the near term. But ultimately we think that Italy’s fiscal disarray will destroy the EU and lead to an Italian exit and currency devaluation with the reintroduction of the lira. In the event, banks in Italy and throughout the Euro area will be severely impacted.

Christopher Whalen is the chairman of Whalen Global Advisors and the author of “Ford Men.” This article was first published by the Institutional Risk Analyst.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

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