Don Quijones: Could Italy’s Banking Crisis Drag Down Mario Draghi?

By Don Quijones, Spain, UK, & Mexico, editor at Wolf Street. Originally published at Wolf Street

A blame game has begun in Italy that risks casting a bright light on the leadership of both the Bank of Italy and Italy’s financial markets regulator Consob. The controversial decision to award the central bank’s current Chairman Ignazio Visco a fresh six-year mandate despite presiding over one of the worst banking crises in living memory has ignited a tug-of-war between political parties and the president, who makes the ultimate decision on who to appoint as central bank chief.

The first to cast aspersions was Italy’s former premier Matteo Renzi, who, no doubt in an effort to distract from his own party’s part in the collapse of Monte dei Paschi di Siena (MPS), called into question the supervisory role of both the Bank of Italy and Consob during Italy’s banking crisis.

Silvio Berlusconi, a key player in the center-right coalition whose party came out on top in recent elections in Sicily, was next to join the fray. “The Bank of Italy did not exercise the control that was expected of it,” he told reporters in Brussels in response to a pointed question about Visco.

As the controversy grows, it risks drawing the role of Visco’s predecessor, current ECB President Mario Draghi, into the spotlight. Many of the key events that helped pave the way to Italy’s current crisis took place during his mandate as governor of Italy’s central bank. And now the skeletons are beginning to crawl out of the closet.

It was recently revealed in a Milan court case that in 2010 Italy’s central bank, run by Draghi, knew that MPS’ management had papered over a loss of almost $500 million in 2010 and failed to report it. It’s not the magnitude of the loss that matters, but how it was done and who knew what and when. Bloomberg:

A 2010 report from the Bank of Italy … shows inspectors were aware that a 2008 trade struck with Deutsche Bank AG was the mirror image of an earlier deal Monte dei Paschi had with the German lender. The Italian bank was losing about €370 million ($431 million) on the earlier transaction, dubbed Santorini, as of December 2008. The new trade posted a gain of roughly the same amount and allowed losses to be spread out over a longer period, the document shows.

The newly revealed report — dated Sept. 17, 2010, and marked “private” — shows the Bank of Italy was aware that by choosing not to book the trade at fair value, Monte Paschi avoided showing a loss at the time. If the bank had used a mark-to-market valuation in the fourth quarter of 2008, it would have been included in its year-end report as the credit crisis was cresting, with potentially grave consequences on the bank’s finances.

One of the main reasons was to hide the losses racked up from MPS’s purchase in late 2007 of Banca Antonveneta, a mid-sized Padova-based bank. This still-opaque deal is arguably the most important banking scandal in Italy of the last ten years, and it directly paved the way to the collapse of MPS.

In its quest for growth at any price, MPS paid €10 billion for Antonveneta, over 50% more than the €6.6 billion Spanish lender Banco Santander had paid just months prior as part of its joint acquisition (with Royal Bank Scotland and Belgian bank Fortis) of Dutch giant ABN Amro. Santander was happy to hold on to the Brazilian side of ABN Amro’s business while hastily disposing of the Italian “assets.”

For Monte dei Paschi it was an ill-timed disaster, just as the purchase of ABM Amro’s disparate other parts had been for Royal Bank of Scotland and Fortis, both of which would end up receiving taxpayer-funded bailouts to stay alive once the post-Lehman hangover hit Europe.

Clearly, there was a chronic lack of due diligence conducted by the banks’ respective boards as well as by the respective national financial market regulators and central banks. In Italy’s case, that meant the Bank of Italy whose chairman at the time was Mario Draghi. Despite serious misgivings expressed by the director of the Bank of Italy’s office in Padova, A. Minnella, in a letter to the Bank of Italy’s head office in Rome, Draghi signed off on the Antonveneta deal in early 2008.

Minella warned of significant “critical issues” in the bank’s technical profiles and competitive positioning, as well as “accentuated problems” that require immediate action by company managers. Antonveneta suffered from serious “financial imbalances” and its sustainability was “at risk,” he added. Yet those warnings were ignored.

In recent years the plot surrounding Antonveneta has thickened further. In 2013 an article in the Italian newspaper ‘Corriere della Sera’ alleged that Monte dei Paschi had signed a secret agreement with Santander and JP Morgan Chase to divvy up the profits from the sale and route them through private banks in Switzerland. So serious was the charge that members of Italy’s fraud squad visited Madrid in 2013 to question Santander’s then CEO Emilio Botin over the deal.

Then there are the reports that MPS’ acquisition of Antonveneta had a total cost of €17 billion, including a €7 billion loan that Antonveneta owed to ABN Amro, while MPS’ total operating capital was just €4.8 billion. Hence the need for so many complex derivatives trades cooked up by the likes of Deutsche Bank, Nomura and JP Morgan Chase to hide the full scale of MPS’ losses.

Some of the bankers responsible are being tried in Italian courts. As has happened in just about every Western jurisdiction since the Global Financial Crisis (bar Iceland), probably no one will be held to account for acts that paved the way to Italy’s existential banking crisis.

And that will almost certainly include Mario Draghi, whose name also popped up recently in a banking commission investigating the Bank of Italy’s chronic mismanagement of the crisis that brought down the two Veneto-based banks. Beppe Grillo’s Five Star Movement has even called for Draghi to be questioned by the commission, but every possible effort will be made by Italy’s financial and political establishment to ensure that does not happen.

Berlusconi, one of the first people to begin piling pressure on the Bank of Italy, described the attempt to drag Draghi into the morass as reckless. “Involving Draghi is really irresponsible — this is the man whose policies helped stabilize the Italian economy and probably saved the euro too,” he said.

The ultimate irony: during his time as governor of the Bank of Italy, Mario Draghi may have played a key role in facilitating the M&A deal that would eventually contribute to breaking Italy’s banking system, but now as ECB president, he has done whatever it might take to keep the Italian economy and its banks afloat, including buying up large amounts of Italian government debt. The ECB is now holding €310 billion of Italian bonds, an amount that exceeds the €246 billion increase of Italy’s national debt since 2012. These aggressive purchases have pushed even the two-year yield below zero (meaning the government gets paid to borrow money). For that alone he can rest assured that Italy’s political establishment has got his back. By Don Quijones.

A sharp dose of Deja Vu for Italy’s teetering banks. Read…  The Next Italian Bank Threatens to Topple