Remember the Italian “doom loop”?

Two months ago we reported that during the first Italian bond market freakout this May over the ascent of the populist due of Salvini-Di Maio to the Italian throne, Italian bank holdings of domestic government bonds rose by a record €28.4bn, more than what was seen during the peak of the European sovereign debt crisis of 2012. Visually, this is what the single biggest month of Italian bank purchases of BTPs in history looked like.

This vicious circle of Country X banks (in this case Italy) buying Country X bonds during times of stress – with the ECB’s trusty backstop – had for years been Europe’s dreaded sovereign bank doom loop. And, as Italy clearly demonstrated, repeated and aggressive attempts by European regulators and policymakers to finally break the “doom loop”, most recently with the introduction of the 2014 BRRD directive, which sought to remove the need for and possibility of bank bailouts, and instead ushered in bail ins, had been an abject failure.

On Monday traders got a harsh reminder of this when Italian banks came under renewed market focus, and selling, due to their inflated holdings of the country’s government bonds whose value has tumbled since May – just as they doubled down on their BTP purchases.

This time, the epicenter of the bank rout was Banca Carige, Italy’s last remaining large problem bank; weakened by years of mismanagement and shareholder infighting, it has fallen behind in the restructuring process that has seen rivals shed bad debts in the past two years. And according to Reuters, healthy Italian banks will be needed to help fill a €400 million hole on Banca Carige’s balance sheet “in order to avert a possible crisis that would further destabilize the sector.”

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