Italian local authorities and financial derivatives: banks profit while workers pay the bill

Since the second half of the 1990s, many Italian local authorities began to delve in financial derivatives to get additional funding[1]. The result was an absolute disaster. In terms of criminal law, the Italian courts are presently in the process of deciding who will pay for such practices. The social cost, however, will be paid by the workers through higher taxes and cuts in public services.

The scale of the problem is enormous. 18 Italian regions out of 20, half of the provinces and more than 700 municipalities bought derivatives, among them big cities like Rome and Milan, but also 82 towns with less than 2000 inhabitants. These numbers exploded after 2001, when Parliament passed laws that explicitly allowed such practices and as a consequence cuts to local authorities became more and more savage.

For years, derivatives seemed a good deal for everyone. Banks enjoyed lavish fees, local authorities received fresh money. But after a few years, it became clear that local authorities were playing with fire and their debts towards the banks began to shoot up.

Everyone knows that financial derivatives are highly risky and destabilizing. Even Warren Buffet, one of the most prominent investors worldwide, has described them as “financial weapons of mass destruction”. When such deals are between the big banks themselves, one can imagine that there is at least a certain balance between the parties – all of them being thieves, they know what to look out for. Here, instead, we had on the one hand huge investment banks with plenty of “experts” in such matters, and on the other local government officers with a minimal understanding of such financial packages and also – as the legal proceedings will probably reveal – with their own personal interests at stake, i.e. they were bribed.

The mechanism used by the banks to sell derivatives to local authorities was similar to that of the "subprime" mortgage deals. Initially, local authorities benefitted from a short-term improvement in their debt situation and had more resources to finance public services (which at the same time also helped line the pockets of businessmen close to them), in the same way that the initial “subprime” repayments were very low to entice customers to take on the mortgage. This, however, came at the expense of an increasing burden later. In the case of mortgages to families, the rate of interest began to rise ruining them. In the case of local administrations, the debts with the banks began to grow evermore, sucking more and more public resources into the coffers of the “friendly” banks. When municipalities and other bodies, such as the Autonomous Region of Sicily, found themselves on the edge of bankruptcy, the Berlusconi government decided to change the law to prevent them from entering into new derivatives contracts.

It was, of course, the classic attempt to close the barn door long after the horse had bolted. In the past few years, the number of local governments with derivatives contracts has gone down, of course. Overall, the market value of these contracts is now negative for 1.2 billion euros’ worth[2], which is a huge problem and could get worse, as the total nominal value of the contracts exceeds 100 billion.

As early as 2009, the “Corte dei Conti” (the Italian Court of Public Finance Auditors) had denounced the reckless use of financial derivatives by the local authorities. In that period, as we have explained, it became illegal for local authorities to enter into such contracts, pending a regulation that has not yet been passed. The point is what is going to happen with the existing contracts.

The cases presently going through the Italian courts will decide on the legal status of the behaviour of the banks towards what were clearly naïve local authorities, but proving the mis-selling will not be easy. The judges will have to demonstrate the bad faith of the banks and that the public officers were in effect a bunch of utter morons. Not many of them will be happy to be presented in such a manner, not to mention the exposure of their possible personal interests. The banks are saying that no one forced the municipalities to buy derivatives. There is also the risk that, as most of the banks that sold derivatives are head-quartered in the City, the latter will request that the trial be moved to the London High Court of Justice, an institution they consider to be more inclined to their version of the facts. As they await the court decisions, some municipalities have stopped paying the banks; some have started litigation, while others are attempting to reach out-of-court settlements. The latter is the case of Milan town council.

Under the right-wing Mayor Albertini, the Milan municipality signed – with five international banks – the biggest interest rate swap of all: 1.7 billion euros’ worth. Already on the day of signing (June 27, 2005), the banks had collected fees to the tune of 50 million euros in exchange for lending 100 million euros in cash to the municipality. Over the years, the trend in interest rates has worsened the debt of the town that has gone well over the 400 million euro mark. Needless to say, the banks did not accept any negotiations until the judge used a very convincing argument: he confiscated their 400 million euro profits. After this gentle "push", they agreed to give back to the Milan municipality 500 million euros in order to close the litigation. Such disputes are increasing.

Solutions?

When the scandal broke out, the government ran for cover by preventing local authorities from any further borrowing involving the use of derivatives. There was talk of “greater transparency”, better information, and easier to understand products. Someone highlighted the conflict of interest inherent in the relationship between the municipalities and the bankers who sold the products pocketing a personal bonus. In the case of the contract with the municipality of Milan, the executives of Unicredit directly concerned granted themselves a bonus of 3.4 million euros each as “compensation” for their part in the disruption of the wealthiest municipality in Italy[3]. Of such “advisors” the city can do without.

Endless chatter about greater transparency and lower bonuses to the bankers is heard after every financial scandal. The outrage is big but the results are poor, as we can see from the constant flow of financial scandals of all kinds. We can safely rule out that such “reforms” will change anything substantial.

Even from the formal standpoint of the interests of the capitalist system, the needs of the Italian municipalities should be met via taxation, and differently from now, by also getting the rich and big business to pay more. The point is that even if the local authorities wanted to delve in derivatives – a risky operation even without the fraud that went on in this case – it was absolutely senseless that the individual authorities should approach banks that were going to cheat them in any possible way.

This scandalous manner of running public finances has simply added to the already unstable financial situation that Italy was in as a whole. It has added an unnecessary further complications to the heavily indebted Italian state, which means the bourgeois are now forced to squeeze the Italian workers even more. It would have been sufficient to create a specialized unit at the “Cassa Depositi e Prestiti” (CDP, a quasi-bank owned by the State) or at the Bank of Italy, that, for free, could find the most adequate and suitable financial arrangements for the individual local authorities. As both parties (CDP and local administrations) were basically part of the same state apparatus, profits and losses of these contracts would have compensated each other automatically with zero net expenses for the public purse. This would be an obvious solution. The problem is that such an arrangement would also obviously not be favourable to the banks. This is another example of the state blatantly defending the interests of finance capital, to the point where it risks destabilising its own system.

The scandal of financial derivatives sold to Italian local authorities shows once again that the banks use the state as a milch cow. And their puppet media limit themselves to lamenting the “cost of politics” and “the inefficiency of public administration”. This is so much hot air for public consumption!

The only way of really avoiding such financial scandals are not repeated is by taking over the banks under workers' control. We cannot trust this state to really do justice.

[1] Derivatives are financial products that allow the buyer or the seller to bet on the performance of other economic variables (from which the products “derive” their value). In this case, local authorities used swaps, products used to hedge or to speculate on interest rates.

[2] Bank of Italy Annual Report, 2012, p. 152.

[3] http://altracitta.org/2009/05/22/scandalo-derivati-ecco-come-le-banche-ingannano-i-comuni/.