Italy Seeks "Silver Bullet" to Clean Up €330 Billion Nonperforming Loans; Explaining the "Bad Bank" Concept

In defiance of eurozone rules against state aid to banks, Italy Plans Bad Bank "Silver Bullet" Bailout.

Italy plans to launch a series of bad bank-style measures as early as the end of the year in an effort to cut its €330bn pile of non-performing loans as it seeks a “silver bullet” to boost its weak economic recovery, say senior officials.

Such a move raises the prospect of a confrontation with the European Commission, which has so far rejected draft plans presented by the Italian Treasury, arguing that any government intervention would qualify as state aid, the officials say.

According to several senior Italian officials, one plan under discussion involves placing the bulk of Italy’s NPLs into a privately held vehicle in which senior debt would be guaranteed by the state, probably through the state development agency Cassa Depositi e Prestiti.

The aim would be to reduce the gap between the price banks are offering to sell the loans and the price private entities are willing to pay for them, which has remained stubbornly wide, amid private investors’ concerns about the ease of clawing back soured loans in Italy.

One senior government official said a clean-up of NPLs would be the single most effective “silver bullet” for boosting Italian growth.

The cabinet was meeting on Sunday for an emergency session, while the markets were closed, to decide measures to inject €2bn to save four small banks — Banca Marche, CariFerrara, CariChieti and Banca Etruria — taken under state control in the past year due to lack of solvency.

Italy’s stock of NPLs hit €330bn in mid-2014, according to the International Monetary Fund. The sum has barely slipped from that level — with a knock-on effect on bank lending. Credit flow to small businesses that make up the bulk of the Italian economy remains stagnant, according to data from the Bank of Italy.

Most recent data show Italy’s economy grew a disappointing 0.2 per cent in the third quarter of this year.

Echoing growing concern among Italy’s business leaders, Citi analyst Giada Giani wrote this week that while the country’s reform momentum had picked up over the past two years, the impact on current growth was probably limited, as signs of improvement to overall competitiveness were scant.

“Once the monetary and fiscal stimuli fade, we reckon Italian GDP growth is unlikely to exceed the 0.75 per cent to 1 per cent range,” she wrote.

Explaining the "Bad Bank" Concept

Take away artificial stimulus and I rather doubt Italy grew at all.

And with €330 billion nonperforming loans does anyone believe the ECB's stress tests that show eurozone banks are well capitalized.

Let's get down to the nitty-gritty of how the "bad bank" construct works and doesn't work.

The idea that you can take bad debt, isolate it, and it then magically becomes good debt, is of course ridiculous. Creating a bad bank does nothing in and of itself.

It is the "government guarantee" that cures the bad bank. And it is taxpayers who pay for the government.

And so here we go again, with another bailout of bondholders, at the expense of the public, and in violation of EC rules, should Italy proceed with the plan.

"At Risk" of Failing Euro Budget Rules

Every country in the Eurozone is "at risk" of violating budget rules for the simple reason nearly all of them currently and consistently violate budget rules.

Nonetheless, on November 17, the European Commission targeted Austria, Italy and Lithuania 'At Risk' of Failing Euro Budget Rules.

The European Union warned Tuesday another three of the 19 countries that use the euro, including Italy, risk breaking the currency bloc's budget rules and hinted it could give France some leeway in the wake of the attacks in Paris.

Though the EU's executive Commission said no country's draft budget has been found to be seriously in breach of the rules, it said Italy, Austria and Lithuania risk overshooting deficit limits in 2016. It urged the countries to revise their spending plans.

Pierre Moscovici, the EU's top economy official, indicated France may get a sympathetic hearing at the Commission if the country's budget plans deteriorate in coming months in the wake of the attacks. The French government has indicated it will boost security spending, which will affect its budget.

The euro rulebook encompasses many requirements, the most important one being that countries keep their budget deficits under 3 percent of annual GDP. If they don't, they must present plans to do so, or face fines. For Italy, the worry is not about the headline deficit number, which is below the 3 percent limit, but the country's ability to handle its debts.

Those under the strictures of a bailout program, currently only Greece and Cyprus, don't have to present plans. And Portugal didn't submit them, apparently because it's effectively without a government following last month's general election. The others, apart from Spain and including France, had presented plans that were said to be "broadly compliant" with 2016 requirements.

"Broadly" Compliant Defined

Broadly compliant means those countries may barely meet budget-deficit rule extensions, granted multiple times already, assuming there is not another economic slowdown nor another wave of terror.

France uses Paris as an excuse, but in reality France would have been "broadly non-compliant" anyway.

Of course, there is nothing magic about 3% deficits year-after-year. Exponentially speaking, even 1% eventually matters. Italy's debt burden that it cannot shrink even though it is compliant with the deficit rule is proof enough.

Mike "Mish" Shedlock