The stories about Monte Dei Paschi didn’t halt over the Christmas break. This is part of the political calculations because the Italians aren’t paying as close to the news as they normally would which means there will be a delayed response. It’s not that Italians are in love with their current government or banking system, but the latest outrage will have to wait a few days. As usual, the statements made the politicians/policymakers don’t make sense, but the markets, when they’re allowed to work, respond as they should.
The most contradictory point the policymakers say with Monte Dei Paschi is about the necessity of the bail in, in the first place. Jens Weidman, the president of the German Bundesbank, makes the point that government interventions should only be the last resort and that the bank should be healthy at its core. These are contradictory because how could a bank be healthy and need help from the government? The goal is to have government help only in the case of temporary liquidity issues. The question remains why the bank is experiencing liquidity issues. The fact is the laws, as they have been drawn up, don’t apply to Monte Dei Paschi, but the politicians will make the square peg fit into the round hole. I don’t see how almost $30 billion in bad loans can be considered a temporary issue. It is the definition of a structural issue.
The only way Monte Dei Paschi’s issues are temporary is if you describe the issues as temporarily bad and getting worse. In the summer, the ECB did a stress test which stated Monte Dei Paschi was solvent, but needed to raise 5 billion euros in case a stressful situation occurred. This is the 5 billion euros Paschi tried to raise from the private market. It failed in this capital raise which is why it’s in this situation. According to the latest ECB report, the bank now needs 8.8 billion euros instead of 5 billion euros. This is why I describe this situation as shoveling money into an incinerator. The money raised is never enough. 20 billion euros the government is expecting to spend on its bank rescue program already represents 1.2% of GDP. The country already has a debt to GDP ratio of 133%. The ever-increasing amount of money Paschi needs could blow a big hole in Italy’s weak balance sheet.
Monte Dei Paschi’s 1-month liquidity ratio fell from 12.1 billion euros to 7.7 billion euros from November 30th to December 31st. This may be because the bank is known to be having trouble, so depositors are taking money out of it. It’s a tough situation for the bank. Because the issue is highly political, it gains increased media coverage. It’s common sense to take your money out of a bank that’s in the news every day for its capital woes. This is also probably why Qatar decided against investing in the bank. This run on the bank can be seen in the chart below as depositors have taken billions of cash out of the bank. This is the liquidity issue the bank has. In a free market scenario banks would be allowed to fail, but instead the Italian government and the ECB are trying to create a safety net. Safety nets are what cause these problems in the first place, but the government never wants to take the pain.
Speaking of safety nets, the government plans to infuse 6.3 billion euros into the bank according to the Italian newspaper. The other 2.5 billion euros would come from the bondholders in this scenario. However, the ECB is proposing the Italian government infuse 4.5 billion euros into the bank and raise 4.3 billion from bondholders. This is the negotiation that will go on over the next few months. The Italian government wants to intervene more to avoid costing any retail investors money on their junior bonds. Monte Dei Paschi stock was halted until a resolution is found.
As I said, each billion extra needed is a big deal because Italy is already highly indebted. The chart below shows Italian banks need $52 billion to cover for bad-loans. This chart came out before the recent news from Paschi, so the number is in the mid-fifty billion euro range. It’s been estimated by an analyst at Deutsche Bank that close to $30 billion is needed from the government. The problem at Paschi has been delayed by a year as the Italian banks don’t want to write down the loans at a price the market is willing to pay. Unicredit seems to be headed in the right direction as it plans to raise $13 billion in new equity to improve its balance sheet. The Italian government is likely to help with the funding of Banca Carige SpA, Banca Popolare di Vicenza and Veneto Banca SpA as well as the smaller banks who don’t have access to the stock market.
To summarize, the three issues slowing down the ability for Italy to sort out its banking system are the lack of willingness to take write downs at market rates, the Italian government underestimating the size of the problem (it can’t afford to do it alone without the private market), and the ECB limiting the ability of Italy to do full scale bailouts. I see this as a ticking time bomb because Italy hasn’t been able to get this settled since the financial crisis which happened 8 years ago. If there’s another crisis, Unicredit will have a tougher time raising money. This is part of why the ECB is continuing the QE until December. There is crisis level monetary policy because a downturn could knock out the banking system.
Conclusion
Monte Dei Paschi is going to need more money than expected which only complicates the matter because Italy is having a tough time convincing the ECB to allow it to bail the bank out. It’s also bad because Italy may need more than $20 billion for its banking system which was already 1.2% of GDP. Italy would probably be able to get this sorted out over the next few years if there were no political issues. We’ll see what the 5-Star Movement will do to solve this crisis if they are elected in the next vote.
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