To escape an onerous derivatives deal with Morgan Stanley, Italy was forced to pay billions of dollars amounting to half of the country's sales tax increase.
When Morgan Stanley (MS) said in January it had cut its “net exposure” to Italy by $3.4 billion, it didn’t tell investors that the nation paid that entire amount to the bank to exit a bet on interest rates.
Italy, the second-most indebted nation in the European Union, paid the money to unwind derivative contracts from the 1990s that had backfired, said a person with direct knowledge of the Treasury’s payment. It was cheaper for Italy to cancel the transactions rather than to renew, said the person, who declined to be identified because the terms were private.
The cost, equal to half the amount to be raised by Italy’s sales tax increase this year, underscores the risk of derivatives countries use to reduce borrowing costs and guard against swings in interest rates and currencies can sour and generate losses for taxpayers. Italy, with record debt of $2.5 trillion, has lost more than $31 billion on its derivatives at current market values, according to data compiled by the Bloomberg Brief Risk newsletter from regulatory filings.
Similar losses have occurred across the United States. The city of Detroit lost $400m to UBS while other such entities including the state of New Jersey, transportation authorities in New York and Oakland, and even Harvard University faced similar losses.
Greece's famed entry into the European Union took place through a crooked swaps deal:
The Hellenic Republic of Greece entered into a similar € 2.8 billion swap with Goldman Sachs in 2001 that came back to haunt them as they faced down default. Local governments in the United Kingdom, Italy and Germany have all been burned by derivatives, some successfully claiming after the fact that the prior governments had no authority to enter into the obligation to avoid payments.
And, in the United States, derivatives fiascos abound, having driven Orange County, California, and Jefferson County, Alabama, into bankruptcy, just to name two of the local governments that have been hard hit.
The city of Milan, Italy took its lenders to court after being charged hundreds of millions
in hidden fees.
JPMorgan Chase & Co., UBS AG, Deutsche Bank AG and Depfa Bank Plc agreed to unwind interest- rate swaps with the city of Milan's government in a 455 million- euro ($600 million) transaction.
Under the settlement, the banks, which are on trial for fraud, closed the swaps today at a "positive" mark-to-market for the city, according to an e-mailed statement from the Italian municipality.
The settlement isn't for damages and doesn't indicate any acceptance of responsibility by the banks, according to the statement. Milan agreed to drop claims for damages in the U.K. and Italy, where the banks face criminal charges. Milan agreed to forego civil claims in return for a "discount' on the cost of closing the swaps, it said. The criminal trial will continue.
Interest rate derivatives are one of the biggest sources of
Wall Street profits:
Interest rate swaps are less often in the news than credit default swaps, but they are far more important in terms of revenue, composing fully 82% of the derivatives trade. In February, JP Morgan Chase revealed that it had cleared US$1.4 billion in revenue on trading interest rate swaps in 2011, making them one of the bank's biggest sources of profit. According to the Bank for International Settlements:
[I]nterest rate swaps are the largest component of the global OTC derivative market. The notional amount outstanding as of June 2009 in OTC [over-the-counter] interest rate swaps was $342 trillion, up from $310 trillion in Dec 2007. The gross market value was $13.9 trillion in June 2009, up from $6.2 trillion in Dec 2007.
In what would appear to be a conflict of interest, the committee that
sets the LIBOR benchmark for interest rates is comprised of representatives from the same Wall Street – City of London banks that most often reference it:
Regulators probing the alleged manipulation of global interest rates are focusing on what traders involved in setting the benchmark say were routine discussions condoned by their superiors.
Staff responsible for submissions to the London interbank offered rate regularly discussed where to set the measure with traders sitting near them, interdealer brokers and counterparts at rival banks, according to money-market traders with direct knowledge of procedures at three firms. The talks became common practice after money markets froze in 2007, making it difficult for individual bankers to gauge the cost of borrowing from other lenders, said the traders, who asked not to be identified because they weren’t authorized to speak about the subject. […]
Spokesmen at lenders that contribute to Libor -- Credit Suisse AG, Societe Generale SA, Bank of America Corp., Royal Bank of Scotland Group Plc, JPMorgan Chase & Co., Citigroup Inc., Lloyds Banking Group Plc, HSBC Holdings Plc and UBS AG -- declined to comment on what internal controls they have for their submissions.
Sadly, private banks have abused a system which is structured to legally provide them with a hefty profit. Through the fractional reserve system, loans are made
worth 25 times more than their own holdings, creating an almost
automatic wealth multiplier for themselves.
The system now in place encourages or compels us all to get and spend money in ways that work against the planet, against other people, and against ourselves.
The great majority of the money supply in national economies is created by profit-making banks writing it into their customers’ accounts out of thin air as bank loans in electronic bank-account money—not coins or banknotes. They call it “credit,” to disguise the fact that it is actually money.
When money starts as debt, paying the interest in addition to the principal requires more money to be earned as income than has been created. That makes it necessary for the supply of money and the accompanying indebtedness in society to keep growing, which has damaging systemic effects for both the environment and society. For example, the economic growth that supports an increasing money supply requires more of the Earth’s resources to be turned into commodities. Growing indebtedness works in favor of those who lend money into existence and against those who borrow and pay interest.