June 26, 2013 6:49 pm
The revelation that Italy’s Treasury is sitting on at least €8bn of mark-to-market losses on derivatives gone sour is politically awkward but of little economic significance. It need not get worse than that, provided Rome now handles the issue openly and competently.
As the Financial Times reported on Wednesday, Rome appears to have entered into interest rate swaps with investment banks in the mid-1990s. These flattered public finance figures through upfront cash payments from the counterparties, by stretching out the government’s debt service over a longer period and by hedging against higher borrowing costs.
It was known that one such contract with Morgan Stanley was settled early last year for a cash payment of €2.6bn from Rome to the bank. It now appears derivatives worth €32bn were restructured in the first half of 2012. At current market prices, the restructuring may have cost the Italian Treasury about €8bn.
That is a big loss as a share of the contracts’ value. As a share of the Italian economy, however, it is a small one-off hit. It is also in part down to bad luck rather than error. It was impossible to predict today’s extreme market conditions in the mid-1990s, in particular that swap rates would be so low just as Italian borrowing costs are high.
That the intended hedging did not work out as planned does not mean Italy’s Treasury, then headed by current European Central Bank president Mario Draghi, was wrong to try. As the Treasury pointed out on Wednesday, there are perfectly legitimate economic reasons for entering such swaps.
There were also, however, illegitimate ones. Rome rejects that the swaps served the political purpose of bringing its public finances in line with the criteria for entering the euro. That denial rings hollow. What is true is that the practice was understood and condoned both by the EU’s formal accounting rules and by the judgment of its most influential political leaders.
Politically, the revelation helps Italy neither at home nor abroad. A Rome prosecutor is complicating life for the government by launching an inquiry. In Brussels and Berlin, the losses will weaken Rome’s hand, even if using swaps to embellish public finance figures before euro accession was a matter of pan-European connivance.
Rome is right to play down the significance of the cost to the Treasury. But it should show that it has nothing to hide. An effort to make public accounts more transparent would not come before time.
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