Italian Stocks, Bonds Collapse After EU Rejects Rome's Budget Plans

Italian stocks tumbled with the FTSE MIB dropping 2.3% - the worst performer among major European markets on Monday - and hitting its lowest level since April 2017, while the country's bonds plunged to the lowest level since February 2014 amid what now appears to be an inevitable showdown between Italy and the EU, after the European Commission said Italy’s budget plans are in breach of common rules.

Over the weekend, the European Commission told Italy it is concerned about its budget deficit plans for the next three years since they breach what the EU asked the country to do in July, but a defiant Rome insisted on Saturday it would “not retreat” from its spending plans.

In a letter to Italy’s Economy Minister Giovanni Tria, the Commission said that with a planned headline deficit of 2.4 percent of GDP in 2019, Italy’s structural deficit, which excludes one-offs and business cycle effects, would rise by 0.8 percent of GDP. Under EU rules Italy, which has a public debt to GDP ratio of 133 percent and the highest debt servicing costs in Europe, should cut the structural deficit every year until balance.

“Italy’s revised budgetary targets appear prima facie to point to a significant deviation from the fiscal path” commonly agreed by European Union governments, EU Commissioners Valdis Dombrovskis and Pierre Moscovici wrote in a letter to Italian Finance Minister Giovanni Tria. “This is therefore a source of serious concern,” the commission’s finance chiefs said in their letter Friday responding to a note sent by Tria the day before.

“We call on the Italian authorities to ensure that the Draft Budgetary Plan will be in compliance with the common fiscal rules,” the letter added at the same time as the council of EU ministers asked Italy in July to reduce that structural deficit by 0.6% of GDP next year, which means the deficit would be 1.4 points off track, Reuters reported.

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After Italy... Spain Risk Soars

Political risk in Europe was largely ignored in international markets because of the mirage of the so-called 'Macron effect', the ECB’s massive quantitative easing program, and a perception that everything was different this time in Europe added to the illusion of growth and stability.

However, a storm was brewing and the same old problems seen throughout the years in Europe were increasing.

In Italy, the shock came with an election that brought a coalition of extreme left and extreme right populists. Disillusion with the Euro was evident in Italy for years, as the economy continued to be in stagnation while debt soared. However, international bodies, mainstream analysts, and banks preferred to ignore the risk, instead continuing to announce impossible growth estimates for the following year and science-fiction banks’ profitability improvements.

Italy’s economic problems are self-inflicted, not due to the Euro. Governments of all ideologies have consistently promoted inefficient dinosaur “national champions” and state-owned semi-ministerial corporations at the expense of small and medium enterprises, competitiveness and growth, labor market rigidities created high unemployment, while banks were incentivized to lend to obsolete and indebted state-owned companies in their disastrous empire-building acquisitions, inefficient municipalities, as well as finance bloated local and national government spending. This led to the highest Non-Performing Loan figure in Europe.

Now, the new government wants to solve a problem of high government intervention with more government intervention. The measures outlined would imply an additional deficit of some €130bn by 2020 and shoot the 2020 Deficit/GDP to 8%, according to Fidentiis

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Italy's Newest Bank Bailout Cost As Much As Its Annual Defense Budget

The Italian Prime Minister himself stated that depositors’ funds were at risk, so the government stepped in with a bailout and guarantee package that could cost taxpayers as much as 17 billion euros.

That’s a lot of money in Italy - around 1% of GDP. In fact it’s basically as much as the 17.1 billion euros they spent on national defense last year (according to an estimate by Italian think tank IAI).

You don’t have to have a PhD in economics to figure out that NO government can afford to spend its entire defense budget every time a couple of medium-sized banks need a bailout.

That goes especially for Italy, whose public debt level is already 132% of GDP… and rising. They simply don’t have the money.

Moreover, the European Union actually has a series of new rules collectively known as the “Bank Recovery and Resolution Directive” which is supposed to prevent failing banks from being bailed out with taxpayer funds.

Here’s the thing– Italy has LOTS of banks that are on the ropes.

So with taxpayer resources exhausted (and technically prohibited), who’s going to be on the hook next time a bank goes under?

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Italy Announces Sketchy Plan to Bail Out Monte dei Paschi

To no one’s surprise, the private sector effort to rescue Italy’s third largest bank, Monte dei Paschi, officially failed yesterday. Recognizing an end game was nigh, the Italian government announced that it would raise its debt levels by up to €20 billion to shore up failing banks.1

It does not take much in the way of mathematical skills to see that €20 billion will not go very far in plugging a hole of €360 billion in bad loans, particularly given that the total equity of Italian banks is only €225 billion. In fairness, not all of the loans are total losers; many would be viable if restructured. However, €200 billion are non-performing. So it’s probably generous (to the Italian government) to assume that write downs would be at least half the total amount, or €180 billion.

So why were some sites, like Business Insider, saying that an Italian rescue might cost “as much as” €52 billion? That’s a lot lower than the hole in the banks’ balance sheets. That is because the bail in rules require 80% of the losses come out of the hides of equity holders and subordinated creditors; the state provides the rest. However, the bail-in rules also stipulate that a bank not be failing.2 Keep in mind that Monte dei Paschi (and no doubt some other Italian banks) are so far gone that they should be resolved, as in nationalized, as the 5 Star Movement is demanding. But the Italian government can’t begin to pretend it can borrow enough under Eurozone rules to provide that level of funding, and the Germans have been incredibly hard-nosed about cutting Italy any slack with respect to its banking mess.

As the very thin press details of the Monte dei Paschi bailout make clear, it’s going to be done at least to some degree in conformity with the new bank bailout rules, which are actually “bail-in” rules. Equity holders, and then creditors are to be wiped out.

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