Theresa May was not the only elephant in the room at Thursday’s European Union summit in Brussels, and EU leaders studiously ignored the other one as well. Paolo Gentiloni, Italy’s new Prime Minister – its fourth unelected one in a row since 2011 - must somehow save Monte Paschi di Siena, the world’s oldest bank, from collapse. If he fails to do so – and much will depend on EU help - then it will set off a chain reaction that could easily engulf the Eurozone.
You might have thought, then, that EU leaders would have had something to say about the matter. But no.
Italy’s third largest bank, founded in 1472 in the city that is nowadays de facto capital of the Tuscan province of Chiantishire - teeters on the edge of the abyss. The European Central Bank has ordered it to raise €5 billion to increase its capital base by close of business on New Year’s Eve or go bust. There are few tangible signs that it will do so. On Tuesday, the ECB refused a desperate last minute request by its board to extend the 31 December deadline until 20 January.
But Monte Paschi - named the weakest of 51 major European banks in July stress tests by the EU’s banking supervisor – is only the tip of the iceberg. Italy’s banks hold €360 billion of bad loans (equivalent to roughly one fifth of Italy’s GDP) which is double the total five years ago. They have dangerously low levels of capital. Unlike American and British banks, they failed to recapitalise after the Great Crash of 2007/8 and kicked the can down the road. They hoped that an economic recovery would save them. It never came.
The other day I spoke on the phone to Steve Eisman, the Wall Street investor who made $1 billion short selling sub-prime mortgage stock prior to the Great Crash and whose story became an Oscar winning film The Big Short.
Mr Eisman is thought to be short selling Italian bank stock big time right now because as he told me: Italy’s banks are 'not in a pretty place'. When I asked him to elaborate, he asked me: 'You heard of the Texas Ratio?' I had heard of the Texas Two Step, I said, but not of the Texas Ratio. It is a stress test – he patiently explained - which predicts bank failure with 100 per cent accuracy. If a bank scores 100 or more, then it is dogmeat.
Monte Paschi scores 140. Only two Italian banks score less than100: Unicredit, the largest, and Intesa San Paolo, the second largest. Both get 90 which means - says Mr Eisman - that they are probably, though not necessarily, dogmeat as well. That’s all you need to know.
Take the biggest Italian bank – Unicredit - whose share price has dropped 53 per cent this year. On Tuesday, it announced emergency plans to reduce its bad loans which total €84 billion. To help do this it plans early next year to raise €13 billion - a sum not much less than its market value of €15.5 billion - in the biggest share sale in Italy’s history. It also plans to sack 14,000 staff (11 per cent) and close a quarter of its branches.
The EU’s fourth largest economy – prisoner of the euro, over-regulation and feeble productivity – has been mired in more or less permanent recession for donkey’s years, which makes the task of saving its banks even harder still. Monte Paschi, whose share price has fallen by 85 percent this year, holds €28 billion in bad loans but is worth only €635 million. In July, the European Central Bank (ECB) ordered it to sell 40 percent of those bad loans by 2019.
So a bail-out by the 66th Italian government (I calculate) since the death of Mussolini now looks like the only card left to play. It is effectively the same as the 65th – minus Matteo Renzi. Sig Gentiloni was Renzi’s Foreign Minister and close ally in the ex-Communist Partito Democratico of which Renzi remains leader.
According to latest reports, Sig. Gentilini is ready to fork out €15 billion to save Monte Paschi and other banks in the front line which Renzi had already decided to borrow just in case. The sum will increase Italy’s sovereign debt – 'the public debt' – which is already 135 percent of GDP - the third highest in the world. Germany’s is 71 percent of GDP, for example, Britain’s 89 percent.
You might say: with sovereign debt already well above €2 trillion, a mere €15 billion is neither here nor there. But as the world saw with the Great Crash there is always a tipping point. And if the wheel flies off, which it so easily might, €15 billion will be as useless as chicken feed. As Italy in particular saw in 2011/12 when the spread between Italian and German government bond yields grew so wide that Italy came close to defaulting on its debt interest payments.
Then, it took direct intervention by the ECB for the first time to save Italy and thus the euro. Ever since, the ECB has intervened ever more heavily – despite German reluctance - to keep the euro alive. But once again, the spread between the German and Italian government bonds is heading into the danger zone.
There is an additional big problem with government bank bail-outs. Under new EU rules which came into force this year a bank’s customers, in particular bond holders, must take a savage hair-cut first – a 'bail-in' - before the government can bail-out the bank.
In most countries, the lion’s share of bank bonds are held by institutional investors but in Italy millions of individual savers hold a total of €200 billion worth of them which they were told were as safe as a normal deposit account.
The task of the new Italian Prime Minister – Foreign Minister and close ally of the previous Prime Minister Matteo Renzi - is a seemingly impossible one: to save a bank, he must sacrifice its savers. Unless – that is - the ECB and the EU agree to relax the new bail-in rules. But as Angela Merkel told Renzi when he was Prime Minister and tried to get her to agree: 'We can’t keep changing the rules every two years.'
Italians used to be the most europhile nation in the EU. They are not any more. The most popular party in opinion polls (on roughly 30 percent) is Beppe Grillo’s Five Star Movement – whose slogan is Vaffa! ('Eff off!) to everything more or less – including the euro. It looks like Italy really is now reaching its Greek moment. I cannot see the euro surviving.
Nicholas Farrell is the Spectator's Italy correspondent