Bloomberg is reporting Italian Shopkeepers Blame Bankers for Losses on Derivatives.

Piera Levo and her husband, who run a 15-employee plumbing supply company in northeastern Italy, bought “insurance” against interest rate increases from UniCredit SpA in 2000.

Six years later, they paid 85,000 euros ($117,000) to extricate themselves from a derivative known as an interest-rate swap that is normally sold to large companies and fund managers. Derivatives are contracts whose value is based on that of another security, index or commodity, or linked to events such as changes in interest rates.

“I had no idea what I was getting into,” Levo said.

[Mish comment: There’s two more lessons for you. 1) Don’t sign anything you don’t understand and 2) When brokers offer to sell you insurance on complex debt instruments, run don’t just walk away.]

Italian banks, including UniCredit and Banca Italease SpA, have sold swaps to as many as 100,000 small businesses, according to lawyers and industry groups. Concern about the contracts intensified last month, when Milan-based Italease said about 2,200 clients may lose 600 million euros on derivatives. Italy’s central bank this week barred Italease from selling its most- profitable derivatives and ordered directors to resign.

The Bank of Italy estimates that non-financial companies had 3 billion euros of liabilities on derivatives at the end of 2006.

[Mish comment: we are coming striking close to finding out that it is indeed Madame Merriweather’s Mudhut in Malaysia who the guarantor of those Italian loans. I am sure the same situation exists in the US. For more on the fine Madame, please see An email from Bernanke. Please read that if you haven’t already. I believe you will find it very funny.]

Banks sold swaps to clients as insurance against rising rates. They also made lots of money. Commissions from sales of derivatives represented 48 percent of operating revenue at Italease in the fourth quarter, according to John Raymond, an analyst at CreditSights Inc. in London.

“These products are very lucrative,” said Jacopo Ceccatelli, a former swaps trader who’s now a consultant to two Italease clients who lost money on derivatives. “If a bank’s sales force has to make their numbers, then this is a way of doing it.”

[Mish question: Is lucrative the right word or is swindle?]

Italease leases everything from digging machinery to cars and real estate. The company’s shares rose sixfold from its initial public offering in June 2005 to Feb. 9, 2007, as it increased leasing, and moved into mortgages and factoring. They have since plunged 72 percent.

Italease, controlled by investors led by Banca Popolare di Verona e Novara Scrl, sells derivatives from outside suppliers to clients with mortgages or leasing contracts. It has to cover losses if clients can’t pay. The Bank of Italy estimates Italease will lose 500 million euros on derivatives contracts opened with clients, Italease said July 25.

[Mish comment: It seems we have found one “mudhut”. There are many more. Q: Why did Italease plunge 72%? A: Because it is increasingly likely that it’s guarantee to cover losses is worthless.]

Italease’s sales pitch for the derivatives centered on the importance of insuring against changing rates, according to the text of a November 2006 presentation to potential buyers.

The bank also proposes a more complex structure based on the number of days an interest rate is lower than a stated barrier. Italease has an option to close the trade unilaterally and free of cost after the first year, a possibility denied to the client.

[Mish comment: There you have it: the famous one sided gold coin. Clever minds will quickly see this is not the same as a double headed or double tailed coin. This magic coin had one head on it. The other side is blank, in sort of a heads I win scenario, tails I get to cancel the deal. Now why didn’t Bear Stearns think of that? Nonetheless Italease is somehow blowing up anyway, no doubt because of leverage or because too many other of its derivative bets are going to hell in a handbasket.]

Unwanted Tools

Meanwhile, back in the states, the Senate panel OKs China currency bill.

The US Senate Finance Committee voted 20-1 on Thursday to give the US government new tools to press China to raise the value of its currency, but the Bush administration said it opposed the bill.

The overwhelming vote shows Congress is headed toward passing legislation by a big enough margin to overcome any presidential veto, said Sen. Charles Schumer, a New York Democrat who helped craft the measure.

The bill’s most significant provision requires the Commerce Department to take “currency undervaluation” into account when calculating anti-dumping duties on foreign goods, said Senate Finance Committee Max Baucus, a Montana Democrat.

That could lead to higher duties already in place on many Chinese products, and encourage US companies to seek new duties on additional Chinese goods.

The panel vote came just a few days before US Treasury Secretary Henry Paulson is headed back to Beijing for talks, including quicker action on currency reform.

“(We) do not believe the approaches taken in the bill reported today would strengthen the hand of the United States in achieving essential economic reform,” the Treasury Department said in a statement.

[Mish translation: We don’t want no stinkin tools.]

The yuan’s value wasn’t the cause of the deficit, Wu said at a dinner in Washington attended by Paulson and Federal Reserve Chairman Ben S. Bernanke in May. About 85 percent of China’s surplus with the US is from foreign companies exporting products no longer made in the US, such as shoes, she added.

[Mish comment: Wu is 100% correct. The source of the deficit is wildcat us financing, a housing bubble, unsupportable consumption patterns by US consumers, etc.]

Sen. Charles Grassley, an Iowa Republican, said the legislation would force the Bush administration to stop “pussyfooting” on the issue by establishing clear criteria to identify countries with fundamentally misaligned currencies, and requiring penalties — such as increased anti-dumping duties — if they fail to make reforms within 90 days.

The bill also would require the Bush administration to take action through the International Monetary Fund and eventually the World Trade Organization against targeted countries that refuse to reform their currency policies.

Another provision would let the Federal Reserve intervene in global markets against the misaligned currency if the country has not made appropriate reforms one year after being cited by the United States.

Anyone who thinks a 25% tariff on goods from China will solve trade imbalances is simply nuts. Can consumers afford a 25% tariff on goods from China? The short answer is “no”. A longer answer can be found in Price Wars as Wal-Mart recently slashed prices on 16,000 items. Obviously there is overcapacity and lack of demand at existing prices. Think about what would happen if Congress does override a presidential veto of such a bill.

A lesson from history: Smoot Hawley Tariff Act.

The Smoot-Hawley Tariff Act was signed into law on June 17, 1930, and raised U.S. tariffs on over 20,000 imported goods to record levels, and, in the opinion of most economists, worsened the Great Depression. Many countries retaliated, and American exports and imports plunged by more than half. The tariff was replaced by lower bilateral agreements in the mid 1930s.

The cause of the great depression is simple: There was a massive runup in credit, margin, leverage and speculation in the late 1920’s. Does that sound familiar? It should. The Smoot Hawley Tariff Act made the great depression worse but it did not cause it as some believe.

Nonetheless, a Smoot Hawley enhanced recession might help clear out the malinvestments that resulted from the fiscal insanity of this administration’s policies, policies at the Fed, and the Congressional spending of both parties.

With the right amount of luck (admittedly a massive amount) it could lead to a total revulsion of credit, a complete repudiation of the Fed, the restoration of sound money and sound fiscal policies. The alternative is a serial bubble blowing exhibition of ever larger bubbles that destroys all that is left of the middle class and culminates with a long retrenchment that drags things out for a decade.

Mike Shedlock / Mish/