Bail-out disguised as bail-in to "save" the Monte dei Paschi bank

The spasmodic evolution of the shares of Monte dei Paschi (BMPS) on the Milan stock exchange is nearing its end, as the reality of bankruptcy and the need for nationalization can no longer be denied.

BMPS stock yesterday reached a new all-time low (see chart 1) and then recovered for no apparent reason, as if the current and potential shareholders were hoping for a miracle that would save them from the imminent bail-in.

The solution of nationalization, regardless of the way it will be promoted and called by the authorities, was somewhat predictable long before the application of the recapitalization program backed by the Italian state.

Beyond the precarious lending standards, which are reflected in the quality of the portfolio of corporate loans and mortgages, most banking analysts claim that the beginning of the end for Monte dei Paschi was the fateful decision to the buy the Antonveneta bank, at the end of 2007, for 9 billion Euros. The merger process ended in 2013, precisely when the losses of BMPS, which had been hidden through various derivatives trades, were revealed and the bank "benefited" from an initial bail-out, of almost 4 billion Euros.

It will be interesting to see if the nationalization process will also include a complete analysis of the way the bank was managed, as well as the naming of those who bear the blame. Between June 2006 and October 2011, it was Mario Draghi who was the Governor of the Bank of Italy.

What exactly did the Bank of Italy oversee during all this time? As a national oversight authority, the Bank of Italy oversees "the careful management of financial institutions and the stability of the financial system", according to its website.

Also, Bank of Italy is designated as the National Competent Authority as part of the Single Supervision Mechanism and it serves the role of National Resolution Authority.

It has now come to the point where the only remaining "savior" is the Italian state, which is itself in a very difficult financial situation.

The 20 billion Euros destined to the financial support of the Monte dei Paschi bank as well as to other banks that are near collapse represents 0.9% of the public debt at the end of October 2016, of 2.223 trillion Euros, according to data from the Bank of Italy. In the first ten months of 2016, the debt has increased by 51 billion, despite the low interest rates generated by the money-printing program of the ECB, after increasing 35.6 billion in 2015.

Sources quoted by Il Sole 24 Ore show that the bail-out of the oldest bank in the world will have several stages and will finish in two or three months. It is extremely important for the program to be credible not just for the bank's creditors, but for depositors as well, who withdrew 14 billion from BMPS in the first nine months of 2016, approximately 11% of the total amount of the deposits, according to a recent Financial Times article.

The first measure will consist of the granting of state guarantees for attracting short term financing, given that BMPS has recently announced a dramatic drop in net liquidity, which would have only been sufficient for the next four months.

The next stage would be the raising of the 20 billion from the financial markets, but a recent Bloomberg article shows that the amount is insufficient for the stabilization of the Italian banking system. The estimates of the news agency indicate that 52 billion Euros are needed to clean up the balance sheets.

La Stampa writes that an emergency ordinance of the government, expected at the late night meeting of the government in Rome, will turn the state into a majority shareholder of BMPS, as the plan has already been approved by the European Union.

But what about the compliance with the European bail-in directive, which requires the application of a haircut to creditors and depositors before a bail-out? Perhaps the "solution" to avoid that has already been found.

According to online publication The Street, the compliance with the letter of the directive implies the application of a massive haircut to subordinated creditors. In the case of BMPS, just like in that of other Italian banks, the majority of these creditors are retail investors, who have been "persuaded" to accept the acquisition of subordinated bonds instead of setting up deposits. That financial "maneuver" was approved by the Italian Commission for the Oversight of Financial Markets itself (ed. note: the equivalent of the US Securities Exchange Commissions).

Due to the social and political implications, individual investors that hold subordinated bonds will be fully compensated by the state, after being included in the bail-in. How? Once again out of the government loans used to save the bank, probably.

Finance minister Pier Carlo Padoan said in the parliament that he doesn't know the exact amount needed for Monte dei Paschi, but that "the maximum of importance will be granted to protecting retail investors, based on the European regulations, so that the impact they will experience will be low to non-existent", according to La Stampa.

The operation to disguise the bail-out as a bail-in will most certainly be a success, especially since the authorities in Brussels, as well as the ones in Berlin, are ready to look the other way, so that not even the illusionist fumbling the rabbit creates embarrassing moments for them.

So that leaves only one unanswered question. How will a bankrupt European country succeed in saving a bankrupt bank of systemic importance, through nationalization?