Modern public debt management and financial innovation have exacerbated Italy’s large, and growing, government debt
The use of financial derivatives by the Italian government continues to appear in the headlines of global news media. Based on Eurostat data, Bloomberg has calculated that in 2015 derivatives-related net liabilities burdened Italy’s public debt by €6.8 billion. If we consider the entire 2012-15 period, the total burden goes up to €21.3 billion, a record in the Eurozone. In addition to this, potential mark-to-market losses were approximately €42 billion during the second quarter of 2014. Italy’s total public debt in 2015 increased to almost €2.2 trillion (132% of gross domestic product), the largest in absolute terms in the Euro area.
Whilst the Italian Ministry of Economy and Finance plays down the impact of these derivatives losses on the stability of public finances, several journalists, politicians and academics are demanding more transparency in the management of public debt. The Italian Parliament is also working on a fact-finding investigation at the moment. Transparency in public debt management is a very important and legitimate request, however, it is a futile request unless we counteract those political-economic forces which are willing to use financial innovation to pursue statecraft objectives. I call this phenomenon financialization of the state, because it exposes state affairs to the very same highly marketised and risk-oriented practices of present-day financial actors. To understand this phenomenon and its impact on contemporary Italian political economy requires looking back to decisions taken 30 years ago.
Beginning in the 1980s, the governments of many countries replaced their traditional methods of public debt management with a market-based approach. They followed the idea that the state should behave as any other actor in the marketplace. In the case of Italy, pro-market experts at the Treasury and Bank of Italy implemented a series of key reforms: a) they diversified the range of government debt securities in favour of fixed-rate long-term bonds; b) they introduced competitive auctions without a base price in the primary market; c) they launched the MTS secondary market, which is today Europe’s leading electronic platform for fixed-income instruments; d) as an adjunct to MTS, they established a market for trading government bond derivatives; e) finally, in the same period, the Bank of Italy reduced its refinancing obligations with the Treasury and began adopting indirect monetary policy instruments.
Hence, by the mid 1990s, the Italian Treasury and Bank of Italy had fully adopted market-based methods in public debt management and trading. The newly established environment exhibited high levels of financialization in the sense that investors could enter or exit positions easily and could execute a wide range of innovative strategies based on short selling and risk hedging. What was initially a market for households, who invested in bonds by holding them until maturity, instead became a highly speculative arena in which large investors imposed financial discipline on the sovereign management of interest rates. Such an environment was established on the basis that Italy could have saved some fractions of a per cent in debt costs. Under this operational framework, the Treasury began to act as a market participant that develops benchmark portfolios to attempt to capture the optimal trade-off between the costs and the risks of debt servicing.
But this was only part of the story. To be sure, the financialization of government bond markets and public debt management exposed government finances to the crisis-prone dynamics of global financial markets. However, it also worked as a channel through which neoliberal minded Italian governments utilised new tools for managing statecraft in a finance-mediated manner and in support of a neoliberal hegemonic order.
In Italy, pro-market experts were appointed as unelected technocrats to run the country in 1993. Centre-left politicians joined forces with them in 1996. At this point, a neoliberal-reformist alliance of pro-market technocrats and centre-left politicians was formed and enhanced its position in the domestic scenario by advocating for a market-oriented modernisation of Italian capitalism. This was done in line with the objective of participating in the Economic and Monetary Union (EMU). In fact, the EMU project has functioned as an external constraint on the country’s traditional political and business establishment which depended on high public debt, the expansion of the state-owned sector, and a highly concentrated system of corporate ownership.
As domestic power struggles gained momentum, it became clear that the neoliberal reformists in power were prepared to deploy all available resources to join the EMU. The accession to the EMU was a crucial point in their statecraft strategies. For neoliberal reformists to dominate the national political scene, Italy needed to be transformed into a modern market economy in line with European directives. It was at this moment that the neoliberal-reformist alliance deployed financial innovation in the most Machiavellian way in order to achieve the crucial objective of complying with the EMU admission criteria. First, they encouraged hedge funds to arbitrage the interest rate convergence between Italian and German bonds via over-the-counter derivatives markets. Second, they used derivatives contracts to window dress the decisive 1997 budget deficit.
As such neoliberal reformists entered into a Faustian pact with global financial markets. They exposed the fabric of democratic life to financial speculation in order to pursue their statecraft aims. Twenty five years later, as the derivatives portfolio of the Italian Republic keeps weighing on public debt in a time of austerity, Italians are paying the price for this short-sighted, undemocratic and financialized politics.
Political and financial institutions shape each other and mutate to impact on all aspects of public life. Simply asking for more transparency in public debt management will not get us anywhere unless we are prepared to de-financialize the entire system of public debt governance and prevent political-economic elites from resorting to risk-oriented financial innovation as a tool of hegemonic empowerment.
This will require addressing crucial questions such as: how do other countries experience the financialization of the state? And what instruments can civil society use to increase the democratic accountability of economic policymaking? It is only by identifying and understanding answers to these questions that the true cost of the financialization of the state, both in Italy and elsewhere, can be assessed.