Bail out? Bail in?: Part 2, Italians aren’t stupid

July 6, 2017 | Banks, Capital markets, Eurozone, Global news, Italy, Markets, Recapitalization, Speculation


By: David A. Smith


[Continued from the previous Part 1.]


As we saw in Part 1, the Italian government is following in a series of national governments (previously Greece, before that Spain) that when confronted with a Brussels-issued ultimatum, reject it:


“We accept it!”

“We reject it!”



Sources used in this post


Zero Hedge, June 1, 2017

AHI post: Twilight at the Groucho Marx club, 3 parts, August 1, 2016; siena font):



The choices are stark:


Ergo, there are only two ways out: (1) Print more money (state capital injection), or (2) Severely cut liabilities via a bankruptcy-like transition.


Now, if Italy had its own currency, Step 1 wouldn’t be hard: you just print liras.  But Italy doesn’t have such a currency and the ECB has given its Nth last chance N+1 times too many already, and Italy’s just rejected Option 2:


After all, the Italian government seems to be radically against a bail-in of debt holders and account holders


This despite the Eurocrats’ Oz-like thundering about its unacceptability:


Who are you and why do you disagree with me?


– even though this is the preferred (read: ‘mandatory’) solution of the European politicians. 


Yet Italy has a reason for its position, at least according to Secular Investor:


The Italian government thinks a bail-in might make things even worse, as the fears of this bail-in might spread to other banks and other institutions inside the Italian system.


That actually makes sense:


Siegfried: How do I know you’re not Control?

Maxwell Smart: If I were Control, you’d already be dead.


And both of us know how to deploy a subjunctive verb …


Siegfried: If you were Control, you’d already be dead.

Maxwell Smart: Well, neither of us is dead, so I’m obviously not from Control.



Shtarker: That actually makes sense.


It may have made sense in the Get Smart context:


A very valid assumption –


But in the context of Get capital, neither position makes terribly much sense.


– but this puts Italy on collision course with the other European countries and the ECB which have been pushing the member states towards using a bail-in as a first solution.


When looking for motivations behind positions, always look to self-interest first.  This can be expressed simply, as follows:


·         If there is a bail-in, anyone who invested in Italy loses.

·         If there is a bail-out, the Eurocrats lose.


Or are they both the same?


Potentially even more important for the Eurocrats, if Italy gets bailed out, then every other dodgy (read: non-German) financial institution in the Eurozone will want the same thing.  The Eurozone is already shuddering badly – do not underestimate the damage the immigration fiasco has done to Brussels’ ability to crack the whip on economic matters, and the upcoming Brexit unpleasantness will further drive a wedge between the ostensibly austere (Germany, and France when anybody’s watching) and the clandestinely profligate (everybody else, including France when nobody’s watching). 


For sixteen years, Europe’s continental leaders have convinced themselves that ‘ever closer union’ (itself a compromise of woolliness) would arise naturally if they all pooled their currencies together to create a meta-currency known as the Euro. 


Though I wasn’t paying attention at the time of the Maastricht treaty creating the Euro, I recall having an inherent skepticism (decades in financial recapitalization builds up your skeptical muscles) as to whether the Euro would actually launch, because Europe had always seemed to me – well, balkanized, to borrow a phrase all the western Europeans would loathe – and I doubted they’d give up their own preferred currencies.  Back then I underestimated how much the weaker-currency countries thought that stapling themselves to a stronger currency would do wonders for their access to capital and hence boost their economies. 


When I finally did pay attention, somewhere after the 2008 US financial crisis leading to the takeover of Fannie Mae and Freddie Mac and the near-seizure of the entire global financial system, it seemed to me that the Euro suffered from the classic problems of unanimity, free riders, and the inability to impose discipline on laggards or holdouts. 


No laggards!


I’ve had years of experience dealing with these in the context of limited partnerships, an archaic but sometimes useful ownership form, and condo/ co-operatives.  In my experience, what applies to quarreling neighbors arguing over who broke the elevator and how much we should pay to fix the roof, or whose responsibility is it to bulwark the beach, applies equally to quarreling prime ministers: whenever the system is consensus-based on unanimity is required for financial contributions, it will break down when confronted with a sufficiently bloody-minded holdout.  If even a few self-interest realists simply dare the others to take themselves down for the sake of taking down the obnoxious holdout, usually some among the frustrated majority will eventually crumple. 


This is especially true if the majority is comprised of ministers and other officials: not only are financial literary and numeracy impediments to getting elected, when it comes to the choice between sacrificing re-election and spending some of the voters’ money in ways the voters won’t understand until later, it’s always simpler to spend the future voters’ money.


Hence, bluster first, then quietly bail out:


Indeed, the whole Euro project is simply the Atlante bailout fund writ large – everyone chips in and no one will ever need to use the fund because it will be so large, shiny, and impressive people will naturally find their common ground.


To my surprise, this worked once for Mario Draghi, when by claiming that he would print whatever money was required, he didn’t have to print much.  It was a feat of staredown politics whose calculation I have to applaud even while deploring the objectives for which he pulled it off.  And I wonder if today Mr. Draghi would have the same view, because after forcing the Spanish and the Greeks to kowtow, his beloved EU has been hit with a rejection that’s not financial but political:


We’re not gonna take it any more!


Brexit changed the equation, not for what it did or will do to the Eurozone economy but for what it is doing to the Eurozone polity – namely, it shattered the belief that Brussels always wins.


That’s why I think Britain will do better in Brexit than the press expects; it’ll be too hard to hold together the Euro coalition and its cacophony of voices, whereas Britain can keep it simple and answers to only one prime minister.


That may not help Italy, but then again, a basic question remains: where is the money to come from?


With a capital hole of in excess of €6.0 billion, there simply isn’t a clear solution for the Venetian banks.




After all, who’d be willing to invest that much money in failing banks?


The answer is simple: only an entity that is willing to lose the money in reality so long as someone allows the investor to pretend the money will be recouped.


Which means government, not private investors, who are using their own money instead of other people’s:


The €6.4 billion might actually be just the starting point. Italians aren’t stupid, and several deposit holders have already started to empty their accounts.


When heading for the exits, do so smoothly and quietly, without spooking others. 


We aren’t talking about a ‘pure’ bank run, but the amount of money which is needed now might be just a very temporary solution. If more deposit holders withdraw cash, more money will be needed to protect the capital ratios of the two banks.


As long as the Euro is portable, it will migrate out of weak banks and weak countries into stronger banks and stronger countries.


So whilst we acknowledge there’s no easy solution, something will have to be done.


That may please German bankers, at least in the short run, but it will leave Germany as the controlling party and principal creditor of a solar system of insolvent satellite countries; in effect creating the bankruptcy of the Warsaw Pact countries without ever having had the pleasure of subjugating them.


And if Italy refuses to apply the bail-in principles, the European Union and the Eurozone might have bigger issues than you’d think…


As a wise man once said, Sooner default is better default.


Bailout?  No, lifeboat time


A new fundamental crisis seems to be just around the corner!


A currency is only something people believe is convertible into localized value:


As Ms. Appendino might say, Let’s assume we have the lira back …


How about a currency when paper was worth something?