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.