Why Did Italy Pay Morgan Stanley $3.4 Billion?

Italy was left to foot the entire bill when Morgan Stanley (NYSE:MS) cut its “net exposure” in the country by $3.4 billion, according to information just surfacing. The firm made the announcement in January that it had cut its exposure by unwinding derivative contracts from the 1990s that had backfired, but it didn’t tell investors that Italy paid that entire amount to the bank to exit a bet on interest rates.

The second-most indebted nation in the European Union, Italy chose to cancel the transactions because it was cheaper than renewing, according to a source with direct knowledge of the Treasury’s payment. With record debt totaling $2.5 trillion, Italy has lost more than $31 billion on its derivatives at current market values.

“These losses demonstrate the speculative nature of these deals and the supremacy of finance over government,” said Italian senator Elio Lannutti, chairman of the consumer group Adusbef. The transaction may prompt regulators to push for greater transparency and regulations on how governments use derivatives.

Morgan Stanley gained $600 million in the fourth quarter from the unwinding of contracts with Italy, about half of the bank’s fixed-income trading revenue during that period, excluding a charge related to a settlement with MBIA Inc. (NYSE:MBI) and accounting gains tied to the firm’s own credit spreads.

To contact the reporter on this story: Emily Knapp at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com

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