The ECB Should Not Purchase Italian Nonperforming Loans

Now we know what doing "whatever it takes" to ensure the stability of the Eurozone means. That July 2015 bluff by Mario Draghi, the ECB President, is now being called. The European Central Bank is in talks with the Italian government about buying bundles of bad loans as part of its asset-purchase program and accepting them as collateral from banks in return for cash, the Italian Treasury said according to Reuters. This announcement reassured the markets if it were to be followed by action.

Last week, the Italian government approved a decree on banking reform but that too was greeted with some scepticism. "We think it represents a step towards a new configuration of the Italian banking landscape. But we still have doubts on whether some of these changes, particularly when it comes to NPLs [non-performing loans], are meaningful enough beyond being a step in the right direction," write Chiara Angeloni and Gilles Moec at Bank of America Merrill Lynch.

The Banking stress tests and ECB supervision failed.

The news that the ECB is asking now what the non performing loans of Unicredit are is one more demonstration that it did not -when it comes to Italian Banks- do its stress test , "the best ever." We know that the non-performing loans of Italy amount to 234 billion euros ($ 260 billions) our of the $ 900 billion estimated by the IMF.

The ECB wanted to supervise important banks, including a number of Italian Banks. They concluded that no important bank in Italy (except Monte dei Paschi) needed additional equity to cover their risks. Whether they lied or did not do their job, the supervisors of the ECB are now facing the moment of truth. The ECB supervisors failed in Italy.

Buying non performing loans would threaten the survival of the ECB.

Central Banks are lenders of last resort and lend to banks in times of crisis. However, they can only do it against quality collateral. the ECB has watered down this principle but never to the point of accepting non performing loans. By definitions such loans are not going to be repaid.

Should they do it, they would not have the ability to manage the recovery of such loans and would probably have to rely on the Italian banks to do so. It would be the same management that allowed their NPLs to reach 17 percent of their balance sheets against seven percent on average in Europe.

There are mechanisms to create a bad bank without the ECB involvement

It is not the first time that bad banks are created to "park" non performing loans at a substantial discount to their nominal value. It is a market and there are ways and means to execute it. The United States remember the Resolution Trust Corporation that rescued the Savings and Loans, China created asset management companies to manage such loans, and so did Ireland, Mexico, Brasil, Russia, Thailand and others.

This should be done with the support of the Italian Treasury not the ECB. Why would Italy be entitled to a privilege that was not granted to any of the other Southern European banks? Is it because Mario Draghi is the former Governor of the Banca d'Italia?

The ECB has no place and no legal right to purchase such assets. For the Italian Treasury to negotiate with the ECB is equivalent to negotiating with itself. Mario Draghi did run the Tesoro for many years. The Governance of the ECB is increasingly questionable.

Unless, of course, the alternative would be the default of Italy....