One might think (and one would certainly hope) that financial institutions would have learned something from the blowup of MF Global and Missing Client Money

One might also think (and again one would hope) in the wake of failing banks like Dexia that financial institutions would have some sense of responsibility as to where they park money.

It goes back a while, but one might have hoped that financial institution would have remembered that E*Trade Nearly Went Bankrupt because it parked client cash position in Asset Backed Commercial Paper right before a credit crunch.

One would be wrong, on all counts.

The New York Times DealBook reports Banks in Italy Find an Unusual Liquidity Lifeline

The London Stock Exchange is becoming the lender of last resort for many banks in Italy as concerns over the country’s debt levels squeeze liquidity out of the Italian financial market.

With cash increasingly hard to come by, Italy’s banks are turning to CC&G;, the exchange’s Italian clearinghouse, for short-term lending. That includes some of the country’s largest financial institutions, including Unicredit and Mediobanca, according to a person close to the situation.

While just two banks received short-term capital from CC&G; in 2009, that number has now risen to 15 — half of them Italian and the rest European financial institutions that trade in the country.

The money, which comes from collateral that traders must put up to complete financial transactions, is deposited with the banks to cover shortfalls in liquidity. CC&G; earns a profit by charging banks interest on the money that they borrow.

CC&G; also doesn’t technically lend money to banks, but instead deposits the cash with them on a short-term basis. Under Italian law, this distinction makes CC&G; a depositor with the banks, and places it ahead of other creditors looking to get their money back if any financial institution should fail.

The legal distinction may still leave CC&G; exposed if a lender defaults. And analysts question the sustainability of lending to struggling banks. That’s particularly true as the collateral offered to institutions as short-term financing is often provided by the same bank’s separate trading operations.

Chasing a few extra basis points of earnings nearly sunk E*Trade. More recently (as in right now), the search for missing client money at MF Global is still underway.

Somehow that has not deterred CC&G;, the London Stock Exchange Italian clearinghouse from taking similar risks for a few extra basis points of earnings.

Mike “Mish” Shedlock
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