Thursday, June 1, 2017

ECB Poised to Approve Italian Bailout of Monte dei Paschi Bank: An Instance of Federal-State Collusion?

Under the E.U.’s banking law enacted after the 2008 financial crisis, the state governments “are not supposed to inject fresh taxpayer money into a bank if it is deemed insolvent. When a bank gets into financial trouble, shareholders and bondholders, assumed to be sophisticated investors aware of the risks, are supposed to take the hit and bear the losses.”[1] Much of the banking reforms were intended, moreover, “to prevent banks from becoming so big and so risky that they could hold the global economy hostage. Politicians and policy makers didn’t want taxpayers to be on the hook for the banks’ mistakes.”[2] What about a mid-sized bank whose financial plight puts a state’s economy and reigning political elite in jeopardy? Should the E.U.’s central bankers look the other way and allow the state’s government to finance a bail-out so stockholders and bondholders need not feel the brunt?
Monte dei Paschi di Siena, one of the largest banks in the E.U. state of Italy, having been “marred for years by scandal, management upheaval, and hefty losses,” stood along with other troubled lenders in the state to gain as much as €20 billion in 2017 from the state government in a massive bail-out.[3] With the bank having lost €3.4 billion in 2016, the European Central Bank had estimated that the beleaguered bank would need €8.8 billion “to plug a shortfall in its capital.”[4] State officials were doubtlessly motivated at least in part out of concern that they would lose power, for “legions of angry middle-class savers” who had bought the bank’s bonds that financed a horrible deal that went bust “would destabilize Italy’s already wobbly government and nourish far-right parties.”[5] Plain and simply, the state party in power was exploiting a conflict of interest wherein the party and its state lawmakers would benefit at the expense of moral hazard—the sending of a signal to bankers that they could take on too much risk without fear of suffering negative consequences because the state would be there to infuse any needed funds. Under federal law, if a bank is insolvent, it is not supposed to be bailed out, and yet on June 1, 2017, ECB regulators “gave their preliminary approval” to the state’s planned bailout of the bank.[6] Because “the finances of [the bank] are open to significant interpretation,” the ECB’s final decision on whether to allow the state government to bail out the bank was deemed to be “in a regulatory gray area.”[7] Therein lies the rub!
Generally speaking, discretion in even a seemingly iron-clad law can enable self-interested political aggrandizement at the expense of the obligation to 1) safeguard the public good, 2) allow the state’s voters to hold the state officials accountable, “come what may,” and 3) stand back as the market holds a reckless and incompetent bank management accountable. Besides making a bad mega-deal and misleading the supporting bondholders as to the risk, the bank’s managers had concealed increasing losses from shareholders and regulators.
In July, 2016, the ECB had conducted stress-tests on the bank. The central bankers determined that the bank’s capital “would be wiped out in the event of a severe economic crisis. No other bank tested fared so poorly.”[8] I would be surprised, therefore, that without the bailout the bank could remain solvent. Hence the purported “gray area” was very likely in actuality manufactured by the sordid collusion between state officials and the federal regulators at the ECB—the latter agreeing to look the other way, in effect, and approve the state’s bailout rather than have the banks stockholders and bondholders—who were admittedly misled—and the bank’s management suffer the consequences as the law required. Power it would seem, flows downhill, circumventing even seemingly iron-clad carved out channels if they are not in the power’s immediate interest. In the end, this case points to the relative frailty of parchment.

1. Jack Ewing, Gaia Pianigiani, and Chad Bray, “Bailout for Italy’s Oldest Bank Tests Too-Big-to-Fail Rules,” The New York Times, June 1, 2017.
2. Ibid.
3.  Ibid.
4. Ibid.
5. Ibid.
6. Ibid.
7. Ibid.
8. Ibid.