Italy’s third largest bank needs a bailout. What happens next could mean a revolution in Rome – or in Brussels.
- By Harold JamesHarold James is Professor of History and International Affairs and the Claude and Lore Kelly Professor of European Studies at Princeton University. His latest book (with Markus Brunnermeier and Jean-Pierre Landau) is The Euro and the Battle of Ideas (Princeton University Press).
Italy’s Banca Monte dei Paschi di Siena would seem to be the archetype of a good, locally based, non-exploitative financial institution. The oldest bank in the world, with headquarters located in the medieval palazzo of one of Italy’s most beautiful cities, it was founded in 1472 as an answer to the problem of providing nonusurious credit to the deserving poor. The American poet Ezra Pound took it as a model for how all banks should operate, explaining in the 1930s that there were two types of banks — the bank of the devils (of which he thought the best example was the Bank of England) and Monte dei Paschi. Pound’s homage to Dante in “Canto 42” also includes a tribute to the bank:
That is a species of bank — damn good bank, in Siena
A mount, a bank, a fund, a bottom an
institution of credit
a place to send cheques in and out of
and yet not yet a banco di giro
In short, it was a bank that really served people and, as Pound explained, gave hope that Italy was “the only possible foundation or anchor or whatever you want to call it for the good life in Europe.”
Remarkably little has changed at Monte dei Paschi since Pound offered that praise. But if the bank, Italy’s third largest, serves as any sort of foundation today, it is the foundation of a financial crisis — one that could determine the political future of not just Italy but the entire European Union.
Over the past 10 years, Monte dei Paschi has required recapitalization three times, receiving a total of 16 billion euros in capital from private sector investors, mostly Italian banks, though not from the Italian government. Last Friday, Italians learned it was the only bank to clearly flunk the most recent European stress tests on financial institutions. The question is what the Italian government will decide to do next — in Rome and in Brussels.
It’s nothing new for Italian banking crises to be intertwined not just with general economic stress but fundamental political transformation. In 1893, a property price crash lead to the revelation of fraudulence at the Banca Romana, one of the country’s note-issuing banks, and the bank’s subsequent failure led to the collapse of the country’s center-left government and a reordering of politics. There are fears that a 21st-century banking crisis could be analogous and destroy the present center-left government of Matteo Renzi. That would lead to a completely new political constellation in which the populist opposition party Five Star Movement, which has already taken over local governments in Rome and Turin, would form a government with the explicit task of having Italy abandon the euro.
But the history of Italian banking crises is also old in the sense of being old-fashioned. Unlike most European banks that have struggled since the start of the 2008 financial crisis, Italian banks have never really been part of the global trend of hyper-financialization. While banks in Germany were busy channeling funds into repackaged U.S. mortgage securities, Italian banks were much more locally focused.
The loans on the balance sheets of Italy’s local banks weren’t made to consumers spending beyond their means, or speculative house purchasers, but mostly to local businesses. Their customers were primarily the country’s large number of small- and medium-sized enterprises, often family-run, with business models not that different from the very dynamic enterprises of southern Germany, Austria, or Switzerland, which concentrate on making niche products — specialized textile machinery, for instance — for international markets.
This throwback banking model insulated Italian banks from the fast-developing financial shocks of 2007 and 2008. At the beginning of the global crisis, as other European governments spent large sums bailing out their banking systems, it looked as if Italy had the most solid banks in Europe. The European Central Bank’s calculation of the fiscal cost of bank bailouts for the 2008-2013 period shows a cost for Germany of 8.8 percent of GDP and for Spain of 4.9 percent, with much higher amounts for European countries that required a bailout from the International Monetary Fund (Ireland, 37.3 percent; Greece, 24.8 percent; and Portugal, 10.4 percent). Italy, by contrast, spent less than 0.2 percent of GDP.
But this encouraged a dangerous complacency in Italy, as a slow-moving economic crisis gradually rotted the country’s financial foundation. A long-standing failure to undertake structural reforms has condemned the country to exceptionally sluggish growth, even before the 2008 crisis. Italy’s clothing and textiles sector has been hit by the move of production to Asia or to lower-cost producers in southeastern Europe; even luxury manufacturers are beginning to outsource production. Eventually, the weaknesses of the Italian economy hit the country’s banks with a massive volume of nonperforming loans — the current estimate is 360 billion euros. (It didn’t help matters that the Italian government is often a hindrance; there are many stories of businesses that contract with the government only to find they are never paid.)
Among the Italian financial institutions struggling with nonperforming loans are big international banks like UniCredit and Intesa Sanpaolo (in both cases around 15 percent of their total loans). Both will need to retreat from some of their international exposures. It is likely, for instance, that UniCredit, which acquired a big central European portfolio when it merged with the German HypoVereinsbank that owned Bank Austria, will sell off its Polish bank holdings.
But the drama of this year’s stress tests focused on Monte dei Paschi. It was the only bank in Europe to get a negative result in the tests, which indicated it would be insolvent in the event of a new European economic downturn. The two larger Italian banks are clearly systemically important, but Monte dei Paschi is also very large, and a failure would destroy confidence not just in the economy but also in the Italian political system. As with the 19th-century Banca Romana, the failure of this bank would destroy the country’s political system.
The problem is that the Italian government can’t really do much about this situation because its hands are tied by EU rules. In response to the bank bailouts elsewhere in Europe, as well as to the political controversies they engendered, the EU reformulated its approach to bank rescues and insisted that some bank creditors, as well as the capital owners, should bear the price of the rescue so that the taxpayer would not be obliged to pay for the incompetence or fraudulence or bad judgment or excessive risk proclivity of bankers.
But these rules will have especially severe political consequences in Italy because of how its banks have funded themselves. For years, Italian banks have not just taken deposits; they have sold risky subordinate bonds to Italian retail investors with little financial knowledge while encouraging the investors to think of the bonds as very safe investments. As some of these banks ran into trouble in recent years, those investors lost large parts of their retirement savings, leading to widespread hardship.
After an elderly holder of subordinated bonds of Banca Etruria, Luigino D’Angelo, killed himself in 2015, the Italian finance minister commented that such bonds had been sold “to people with a risk profile which isn’t compatible with the nature of these securities.” The EU commissioner for financial services, Jonathan Hill, echoed this critique with the now-familiar accusation that banks were “selling unsuitable products to people who maybe didn’t know what they were buying.” The Italian response was to set up a special fund to assist on a case-by-case basis those who lost large amounts in the course of any resolution of a failed bank.
For Monte dei Paschi, shareholders have already lost almost all of their investment. But the government does not want to see a repeat of the bank resolutions of 2015, even though some European policymakers argue that the bondholders who might lose are mostly quite wealthy people — and not the poor pensioners whose bailing in would be politically toxic.
The Italian government has argued that since its banking crisis originated in a different way than other European countries, those peculiar origins should be taken into account when it comes to designing a policy response. But policymakers in northern Europe simply respond that Italy is facing the penalty for its delay in action on a central economic issue. The new rules came into effect at the beginning of this year and clearly mean that Italy cannot bail out its banking sector today. The Italian government’s hands are firmly tied.
So all the government can do is organize an international rescue from private investors, backed by the promise of a breakout from Italy’s low-growth trajectory. The first phase of this year’s Monte dei Paschi rescue involves transferring about 9.2 billion euros of bad loans (whose nominal value is some 27 billion euros) to a rescue fund called Atlante, financed by Italian banks, insurance companies, and pension funds. Once a substantial part of the bad-loan portfolio is no longer on the books, there will be a 5 billion euro capital increase underwritten by a consortium of banks led by JPMorgan Chase and Mediobanca and involving six other investment banks with pre-underwriting agreements: Goldman Sachs, Santander, Citi, Credit Suisse, Deutsche Bank, and Bank of America Merrill Lynch. In short, the international banking system is being brought in to rescue Monte dei Paschi.
What’s remarkable is that throughout this budding crisis, Italian policymakers and regulators have maintained their consistently upbeat refrain, at least in public, about the prospects of Monte dei Paschi. This was true even two years ago, when the bank’s previous chairman, CEO, and chief financial officer were jailed for misleading regulators about the bank’s condition. Alessandro Profumo, Italy’s best-known international banker, who had negotiated UniCredit’s merger with HypoVereinsbank, was chosen to replace Giuseppe Mussari as chairman and claimed in May 2014 that he had done his job. “[Monte dei Paschi] is no longer a problem for this country. It has gone back to being a normal bank and is healed,” he said. Just over a year later, Profumo stepped down. At the beginning of this year, Prime Minister Renzi said: “Today, the bank is healed, and investing in it is a bargain. [Monte dei Paschi] has been hit by speculation, but it is a good deal. It went through crazy vicissitudes, but today it is healed —it’s a good brand. Perhaps this process of finding partners will last several months, because they must stand together with others.”
These upbeat assessments by policymakers are the key element of Italy’s rescue strategy. They clearly amount to some implicit political guarantee to private investors who might be wondering why they support an institution that has already burned through so much capital. A general economic recovery is just around the corner, the Italian government is saying, and when those conditions improve, the bank’s profitability will return.
The upshot is that the only way to avoid dramatic political changes in Italy, which would have political fallout across Europe, is to preemptively make policy changes at the EU level. But in order for its rosy scenario to play out, the Italian government has no choice but to push for an end to the EU’s commitment to fiscal austerity. Renzi’s government believes there is substantial support for such a shift in other European countries, above all in France, and it has recently been pushing for a much larger EU public spending initiative, directed primarily at infrastructure investment.
In Giuseppe Tomasi di Lampedusa’s great novel The Leopard, Tancredi Falconeri states: “If we want things to stay as they are, things will have to change.” If the government isn’t allowed to help banks directly, it has to commit itself to a new growth dynamic for the entire continent. It remains quite uncertain that it can — or will be allowed to — follow up on that promise.
Photo credit: GIUSEPPE CACACE/AFP/Getty Images