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Friday, January 25, 2013 12:57 PM

Much More Beneath the Surface of the Italian Bank Scandal; How Big Are the Derivative Losses?

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Yesterday I commented on how Italy's 3rd largest bank hid derivative losses,how it might affect the upcoming Italian elections, and why ECB president Mario Draghi should be under fire as well.

For details, please see Italian PM Under Fire; Italy's 3rd Largest Bank Hid Derivative Losses: ECB Says "Matter for the Italian Authorities" (To Sweep Under the Rug).

As is typically the case, there is more going on than mainstream media reports. I bounced my article off reader Andrea who is from Italy but now lives in France. Andrea writes ....

The article you reported is very well done and describes almost all the facts of the situation.

What is not reported is that Giuseppe Mussari, the recently resigned head of ABI (Italian Bank Association) was the CEO of Banca Monte dei Paschi di Siena at the time of the derivative losses. He resigned following the scandal, but this casts a very negative shadow on the overall banking system. It also makes open a discussion about the widespread belief (repeated as a mantra by the whole political class) that the Italian banks were wiser than foreign counterparts, not involved in toxic things and therefore not needing huge bailouts or supports like anywhere else in the world.

This scandal blasted like a bomb in the campaign. Monti is most likely the one who will be hurt. However, It's unclear who can take advantage. The center-left was at the government only 2 years (2006-2007), so it is quite hard to find evidence to give the blame just to them.

The Economy Ministry and Bank of Italy are blaming each other about the lack of supervision, for different reasons. The probable truth is that both lacked of supervision for their respective parts.

Most likely prosecutors will open an investigation (they are obliged by law to do so in Italy if they are informed of a possible crime) and this could lead to further discoveries.

I think that for Monti to appear in the Parliament to speak about this in the middle of the campaign and with his image of "friend of the finance world" could be a very painful and delicate exercise

So, to summarize, I think we are at the beginning of the story. In an Italy under a bombing of taxes, huge recession and lack of credit from the banks to the real economy, this will be hard to be swept under the rug. The message "the taxes you pay are used to help banks getting out of their toxic speculations" is very easy to deliver in such circumstances.

Best regards,

Tangled Web of Giuseppe Mussari

Inquiring minds may be interested in the tangled web of places where Giuseppe Mussari had tentacles.

Could he and did he hide all of this from the Bank of Italy, then headed up by current ECB president Mario Draghi?

How Big Are the Derivative Losses?

While pondering what Dragi knew or didn't, let's turn our focus on actual losses. Reuters reports Monte Paschi Shares Plunge on Derivative Loss Fears
Shares in Banca Monte dei Paschi di Siena, Italy's third-biggest lender, fell more than 5 percent for the second day in a row on Wednesday on worries of mounting losses on some financial derivative positions which it took in 2008 and 2009.

The price had already dropped 5.7 percent on Tuesday after reports that it is expected to book a loss of at least 220 million euros ($292 million) on one particular derivatives deal related to its debt holdings done three years ago.

That deal, called Alexandria and designed by Japanese bank Nomura, is one of several troubled structured transactions the bank is reviewing to assess their impact on its accounts, Monte dei Paschi said on Tuesday.

At least one other derivative trade, a 2008 deal with Deutsche Bank, is also thought to be under scrutiny, analysts and banking sources say.

The loss on the deal with Nomura is the latest setback for Monte dei Paschi, which requested 3.9 billion euros in state aid to plug a capital hole stemming from its government bond portfolio and hedging bets gone wrong. The bank had already raised its state aid request by 500 million euros in November, citing a possible hit on its capital from past structured transactions still in its portfolio.

But some analysts are beginning to question whether that 500 million cushion will be enough to cover for any losses linked to the derivative contracts. Italian newspaper Il Fatto Quotidiano quoted an anonymous source on Tuesday as saying the loss on the Nomura trade alone could amount to 740 million euros.

"If losses above 500 million euros emerged, the group would struggle even more to fix its capital position," Comi said.

Nomura said on Tuesday the trade had been approved by the Italian bank's board and its then chairman Giuseppe Mussari, but Monte dei Paschi said the Alexandria deal had never been submitted to its board for approval. Mussari stepped down late on Tuesday as head of Italy's banking association, denying any wrongdoing.
This mess should hit Draghi and the ECB, but they will do everything possible to sweep it under the rug. Nonetheless, it is highly likely to impact the elections as Andrea notes.

If the losses are big enough, Banca Monte dei Paschi di Siena faces nationalization.

Mike "Mish" Shedlock

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