This week Monte Dei Paschi, the weakest Italian bank, is under renewed scrutiny because it still needs to raise money to recapitalize and get rid of 28 billion Euros in bad loans it has. The reason why I focus on this issue is because of the two risks in play. The first is the potential bondholders face losses. This is a big risk because the Italian bankers and politicians decided it was a good idea to get everyday citizens to buy Monte Dei Paschi bonds. It’s almost as if the politicians and bankers are trying to destroy the economy. I couldn’t think of such a bad idea if I tried. Any hair cut on these bonds will hurt the economy because Italians viewed this as a secure investment.

The second risk is Italy leaving the Eurozone. There are restrictions with taxpayers footing the bill for bailing out the banks without the bondholders taking losses. If the Italian government violated these rules, it could be kicked out of the EU. The restrictions are the equivalent of leaving a kid who hasn’t eaten all day at a candy store with no supervision and telling him he can’t eat anything. The banks are already undercapitalized, so allowing them to fail or nationalizing them are the only options. The laws against bailing out the banks needed to come before the bad loans were made to influence the potential moral hazard.

The situation is complicated as one would expect from a nation which has a failing banking system. The goal the politicians have is to avoid the citizen bond holders losing money and provide a capital injection without violating any of the bailout rules. I think this is the most likely scenario which means the can will get kicked down the road again. That doesn’t mean it won’t get interesting.

There are three separate issues taking place this week. The first is the convertible option for the bank’s bondholders. Retail investors have until Wednesday to decide if they want to convert their junior bonds into stocks and institutional investors have until Thursday to decide. The goal of this is to get 28 billion Euros of bad loans off the balance sheet. The situation is a house of cards, so bondholders may decide to make the switch to keep it going. 35% of the shares are being offered to retail and 65% to institutional. Existing shareholders get access to 30% of the shares for retail before it’s available to outsiders. The deal involves the exchange of 4.5 billion Euros of Tier 1 and Tier 2 securities.

This reminds me of the Tesla shareholders vote on whether to acquire Solar City. It ended up 85% of the shareholders voted for the deal as I predicted. This because if they voted against the deal, it would’ve knocked down Elon Musk’s house of cards. They decided avoiding this risk was worth Tesla taking on the Solar City debt load. Getting Monte Dei Paschi shares is a raw deal, but the bank needs this to work to survive. The bank is trying to raise 5 billion Euro from the private market by the end of the year. According to Reuters the private capital raised from this swap isn’t going well so far.

The second issue is the Italian government securing the funds necessary to bailout the banking system. Prime Minister Paolo Gentiloni is convening a cabinet meeting to request funds from parliament. The government is ready to infuse 15 billion Euros into the banking system. Of course, the government will get the money it needs for the bailout of Monte Dei Paschi. Even though I said there are restrictions to the government being able to bailout the banks, there is a loophole which will be used to help Paschi.

The loophole is called “precautionary recapitalization” because the bank meets capital minimums. It’s a ridiculous situation because it’s clearly a bailout because the bank doesn’t have enough capital. It’s like if a person is drowning and a lifeguard saving him was considered a precautionary measure. According to Article 32(4)(d)(iii) of the European Banking regulations, only junior creditors have to take losses, while senior creditors and depositors don’t have to take any losses. As I said in the beginning, this means the most likely scenario is a bailout happens without everyday citizens losing money.

The third issue is the one we know the least about. Quaestio Capital Management’s Atlante, a government created bailout fund, is considering investing 1.53 billion Euros in the 28 billion Euros of bad loans Monet Dei Paschi is trying to get off its balance sheet. The bank is reliant on this investment by the end of the year to make the deal go through. The reason why Atlante is having reservations about the deal is unknown, but considering that the fund is backed by the banking system itself and was set up to make this type of deal, I can’t imagine why it wouldn’t go through with the deal. Unicredit, Italy’s only systemically important bank, put $1 billion into this fund. Unicredit announced last week that it would be firing 11% of its workforce or 14,000 workers and raise 13 billion Euros in a share issue by 2020. Welcome to Italy, where weak banks bailout weaker banks and the government backstops it all!

Conclusion

One other part I didn’t mention is Monte Dei Paschi is raising 4.7 billion in a bridge loan with JP Morgan, Mediobanca, Credit Suisse, and HSBC. Creativity on how to save Monte Dei Paschi has no bounds. Too bad this ingenuity with creating bailouts wasn’t used to help to bank run better. Then it wouldn’t be in this mess.

There will be excitement in the next few weeks, but there’s not much that will change if the situation plays out as I expect. These endless bailouts provide fuel for the populist political risk which is spreading across Europe. It boosts the odds Italians will vote for the 5-Star political party and eventually to leave the Eurozone. Just because there won’t be a big crash this week doesn’t mean this situation isn’t dire. Every day the economy isn’t restructured is another day where the economy gets worse.