The day the zombie bank Monte Dei Paschi is rescued is finally upon us. The bank tried to raise 5 billion Euros through the private market, but failed. The bondholders’ debt for equity swap only netted the bank 2.45 billion Euros. The Qatar sovereign wealth fund decided not to make a 1 billion Euro investment because of political risk. Bondholders were conflicted because they wanted the deal to be a success so their bonds didn’t take a loss, but they personally didn’t want to go through with taking on the risk of taking equity because that could potentially bring them losses. Monte Dei Paschi stock fell 7.48% today on the news of the failed rescue which had the aim of getting the 27.7 billion Euros in bad loans off its balance sheet. The stock is down 32.29% in the past month which is why bondholders didn’t want equity. However, if the deal was a success, the stock would have rallied, so the decision on whether to take stock or equity was a calculated risk on both sides. It will now need the government to bail it out.

The story of Monte Dei Paschi is one of endless regulations and loopholes. By learning about the situation and the potential results, you can see why the country is in this situation to begin with. The political issue is also a microcosm of the problems the country has seen throughout its recent history. While political or financial changes are usually the source of problems, in this case, the source of volatility is nothing changing. Reform needs to happen for the country to get out of its own way. That’s why some would support Italy leaving the EU because it may ‘shake things up.’

The Italian parliament has agreed to a 20 billion Euro package to rescue its unstable banks. The six largest banks are estimated to need 30 billion Euros to clean up their bad debts and the entire Italian banking system is estimated to have 360 billion Euros in bad loans. On the bright side, JP Morgan and Mediobanca won’t be getting compensation for the deal. The negative side is that the 4.25 billion Euro Atlante fund which was backed by banks like Unicredit, didn’t serve its purpose which was to help the beleaguered banks. The Italian banking system is a sinking ship, so the Atlante fund was a plug that didn’t stop the water from coming in. The future of the fund is in question. In the worst-case scenario, the fund won’t even be able to raise money because Unicredit could feel the effects of the Monte Dei Paschi failure.

As I have mentioned every time I discuss this situation, the key takeaways are what happens to the retail debt holders and the political repercussions for this bailout. The two are intertwined. It’s estimated that 2 billion Euros of bonds are owned by private investors. These are the investors who need to be protected. The institutional bondholders will take a greater haircut. The 40,000 retail junior bondholders are expected to get awarded 80% of their losses if they can prove they have low income or were a victim of predatory selling practices. The Italian government will try as hard as possible to make sure the losses are kept to a minimum because it carries high political risk. This will be decided in Brussels. Even though the leaders in Brussels aren’t directly elected, they also face political risk because if the retail investors have to take too much of a loss, Italy will rebel from the EU.

If you can believe it, Matteo Renzi, the prime minister who lost the referendum a few weeks ago and stepped down, will be vying to be the prime minister in the next election under the banner of the Democratic party. The Democrats are in a tough situation because Renzi has the best political skills to negotiate with Brussels, but he’s also just lost, so he’s toxic in that sense. The situation will only get worse for him because news of the Monte Dei Paschi failure will only hurt his cause. It must be disheartening for him because if he was in office over the past few weeks, the bailout would have had a better chance of succeeding. He’s taking the political brunt for something he couldn’t control.

Italy is also in a tough situation in terms of funding the bailouts of the troubled banks. The 20 billion Euro bailout authorization is 1.2% of GDP. Italy is aiming to own less than 50% of Paschi. The 20 billion Euro fund will make Italy’s 133% debt to GDP rise even higher which is supposed to be restricted from going much higher by European regulations. Italy will argue to the European leaders that this bailout won’t impact its structural balance. This is laughable because the structural weakness is why this bailout is taking place in the first place. Calling this a one-time event is like someone with a cold promising they will never sneeze again.

The takeaway from this situation is Monte Dei Paschi is being somewhat nationalized. It won’t cause losses from retail investors, but it will still cause political strife as the status quo Democratic party should face more losses from the populist parties in the next election. The populist parties aren’t completely in favor of leaving the Euro, but they are more sympathetic to the concept. However, these parties winning is a signal that Italians aren’t satisfied with being in the EU, so it will be more likely to happen if they win. The best-case scenario for Italy staying in the EU would be if Monte Dei Paschi is able to get the bad loans off the balance sheet and re-enter the private market in 2 years as a healthy institution ready to make loans.

Conclusion

Monte Dei Paschi is a symbol of the problems Italy faces as the country is in desperate need of reform. Instead of getting reform, the country is left with trying to cobble together enough money to save its third largest bank. Every lost election by the Democrats and failure in the banking system brinks us closer to the political event everyone is waiting for: Italeave.