

The prosecution relates to a huge bet on interest rates that the four banks—UBS, JPMorgan Chase, Deutsche Bank and Hypo Real Estate's DEPFA unit—helped the city authorities to take in 2005. The banks helped arrange the sale of €1.7 billion ($2.3 billion) of bonds for the city and then also helped it swap the fixed interest rate it was paying on the bonds for a lower, floating rate. Part of the contract is thought to have involved a “collar”, a way of limiting the range of outcomes on a bet, which protected Milan from rising rates but which also meant it would have to pay out if they fell.



Other egregious examples of financial incompetence can be found in nearby Germany, where scores of public authorities also signed contracts that they seem not to have understood. In Leipzig the courts have been asked to rule in a dispute between the city and UBS. That case relates to a complex sale-and-leaseback agreement that the city signed for its local waterworks. Part of the deal reportedly entailed the city agreeing to insure a portfolio of loans against default through a collateralised-debt obligation (CDO). Making good on those loans may bankrupt the city.



Sorting out this mass of claims and counterclaims will keep lawyers busy for decades. In the meantime, cities can expect to have less room for financial manoeuvre. On March 11th Italy's Senate Finance Committee endorsed proposals that will restrict the use of derivatives by municipalities. It will, for instance, force them to get an opinion on a proposed deal from the Economy Ministry and require them to prove that a transaction would leave them better off than simply repaying their current debt. To keep dancing, high finance and low-level bureaucrats may need a chaperone.