German banks bear a priced risk

Market Watch: Italy’s government has set up a backstop fund to shore up troubled banks, setting the stage for the rescue of troubled Italian lender Banca Monte dei Paschi di Siena SpA.
 At a cabinet meeting in the early hours of Friday, the government of Prime Minister Paolo Gentiloni approved the creation of a €20 billion ($20.9 billion) fund to help troubled banks. Shortly afterward, Monte dei Paschi BMPS, -7.48% said it will apply to tap this fund for fresh equity to shore up its balance sheet.
 The government’s decision comes just hours after the Tuscan bank declared that a last-ditch effort to raise capital from private investors has failed. The bank, Italy’s No. 3 lender, attempted to raise €5 billion to stay afloat and avert a government bailout. The government said that if a bank taps the newly created fund, its outstanding junior bonds will be forcibly converted into shares. European rules on bank rescues require that investors suffer at least some losses. However, under the terms attached to the Italian government’s new fund, the losses suffered by holders of Monte dei Paschi’s junior bonds appear to be fairly limited.

In short, the Italian government is going to borrow money and buy bank shares, taking it over.

Who buys the ten year bonds? The ECB and German pension funds.  But the ECB has a fixed membership with Germany owning about 20%, and making few, if any, loan payments back.  All the others are paying rates in, deeper in debt, especially Italy.  So, German central bank accumulates, or German private mega-bank accumulates.

This is all time sequenced payment flow back to German middle class.  Time sequenced means that the Italian government is well functioning for about 5 years, a fairly regular routine.  Probability low.

Been there twice, however, with  Greece.  Hence, the risk is well priced, two samples gains the most information.  The Italian ten year is only 1.85 or so, less than the US rate.  The extra interest payments might jump that a half point. But Italy is in deep roll over doo doo, over a GDPs worth of debt rolls at that new rate, soon. So Italy parliament will see its interest payments go from about 4% of GDP to about 6^ of GDP, and real soon.  And that fouls the election something fierce because everyone's favorite government goodie is under threat. Germany will bear the blame.

What should the German government do?  They are forced to bear a responsibility to manage the Italian budget.  How? They have no secure smart card to gain insider information down there.  If they could trade deeper into the Italian system, they could get their hedges before it reaches the international flow level.