Italy's banks shaken as economic slump deepens

With the world's third largest debt after the US and Japan at €1.9 trillion (£1.18 trillion), it is big enough to bring the global financial system to its knees. It is also in the front line of contagion as the Greek crisis metastasizes.

Yields on 10-year Italian debt jumped 16 points to 5.86pc on Tuesday after Italy's data agency said the country is sliding even into deeper recession, with GDP shrinking 0.8pc in the first quarter.

Output is now 6pc below its peak in 2008. Italy has been trapped in perma-slump for a decade, the only major state to suffer a fall in real per capita income since 2000.

Rising anger has led to a spate of violent attacks by terrorist groups over recent weeks, all too like the traumatic 'years of lead' in the late 1970s. The government is mulling use of troops to protect targets after anarchists shot the head of Ansaldo Nucleare last week and hurled petrol bombs at tax offices.

The unelected government of Mario Monti is carrying out net fiscal tightening of 3.5pc of GDP this year even though Italy's budget is near primary surplus. This is three times the International Monetary Fund's "therapeutic" pace. All key measures of Italy's money supply have been contracting at 1930s rates over the last six months.

Hans Redeker from Morgan Stanley said the EU's mishandling of Greece has put Italy in grave danger. "The irrevocability of the eurozone is a valuable asset, and they are throwing it away. Global investors are preparing for the day Greece leaves," he said.

The IMF said Italian bank exposure to the state is 32pc of GDP, including all forms of lending. "We are looking at this number very closely," said Mr Redeker. Almost half of this is owed to foreigners. Italy's central bank owes a further €278bn in 'Target2' claims to peers in Germany, Holland, Finland and Luxembourg, reflecting capital flight.

Italy's former premier Romano Prodi said the EU risks instant contagion to Spain, Italy, and France if Greece leaves. "The whole house of cards will come down", he said

Angelo Drusiani from Banca Albertini said the only way to avert catstrophe is to convert the European Central Bank into a lender of last resort. Otherwise Italy faces "massive devaluation, three to five years of hyperinflation, and unbearable unemployment."

The ECB's emergency lending may have made matters worse, encouraging banks to buy their own states' debt. It has led to an incestous inter-linkange of fragile banking systems and fragile sovereign states, each propping the other up. Many of the banks used ECB money to buy state bonds until they need to roll over their own debt. They are now nursing stiff losses.

Moody's downgraded 26 Italian lenders on Monday night saying the slump itself is the killer, joining a chorus of voices warning that too much austerity may be self-defeating. "Banks are vulnerable to the renewed recession in Italy, given their already elevated levels of problem loans and weakened profitability," it said. Moody's expects the economy to contract 1.9pc this year.

The Italian Banking Association ABI accused Moody's of an "irresponsible, incomprehensible, and unjustifiable" smear. "Moody's decision is an attack on Italy, its companies, its families and its citizens," it said, calling on the EU authorities to clamp down "severely" on rating agencies.

The agency said the "problem loans" of Italian banks have reached 9.3pc. The figure may be higher, given "concerns about the accuracy of reported non-performing loan measures." They depend on capital markets for 36pc of their funds. This source of finance has largely dried up.

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George Osborne wins battle for tougher rules on UK banks

The agreement struck in Brussels yesterday between European Union finance ministers will allow the UK to implement key policies recommended by the Independent Commission on Banking (ICB) last year, such as retail ring-fences and 10pc capital buffers, designed to protect the country from another financial crisis.

The Chancellor fought off stiff opposition from France in particular, which wanted to strip national supervisors of authority by centralising banking regulation in Brussels.

However, he failed to overturn attempts to water down Basel 3, the internationally agreed standards on banking regulation, and was threatened with a new battle after Michel Barnier, the EU’s financial services commissioner, revealed plans for a controversial bonus cap.

Under governance reforms he is championing, Mr Barnier wants to limit bonus awards to a multiple of both salary and the bank’s lowest wage.

Mr Osborne is already facing a fight with the European Parliament over plans to prevent banks paying bonuses that are larger than salaries in the next round of negotiations over regulation.

Mr Barnier said he wanted shareholders to set the ratios and, echoing Vince Cable’s reforms in the UK, intends to give investors a binding vote on pay.

Mr Barnier’s plans will have soured the Chancellor’s mood after the European Council agreed that banks should comply with the central Basel 3 requirements of holding 4.5pc core tier one capital and a further 2.5pc counter-cyclical buffer against potential losses.

Mr Osborne was less successful on the issue of too-big-to-fail banks, though. The directive did not enforce Basel 3 rules that require the largest banks to hold a further 1pc to 2.5pc of capital.

Britain will still be able to implement Basel 3 in full, however, thanks to a clause clearly added for the UK’s benefit that said “member states would be able to apply systemic risk buffers of up to 3pc for all exposures?.?.?. without having to seek prior Commission approval”.

An earlier draft would have required sign-off from Brussels for any decision to raise capital ratios above 7pc, which Mr Osborne said at the time would have made him “look like an idiot”.

Although the directive as it stands will allow countries to opt out of the stricter Basel 3 rules,

Mr Osborne said any member states that did would be punished by the markets.

The directive also gave national regulators the power to use macro-prudential tools, such as loan-to-value mortgage caps, to rein in excessive lending without consulting Brussels. Supervisors could increase the risk weighting of assets by up to 25pc, as well.

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Fed's Fisher: Texas banks "best run" in nation

By Marice Richter

FORT WORTH, Texas (Reuters) - Banks in the Lone Star State have been more profitable than those in the rest of the United States for the past five years, Dallas Federal Reserve Bank President Richard Fisher, a leading critic of the nation's biggest banks, said on Friday.

The comments come a day after JPMorgan, the second-biggest U.S. bank, revealed a $2 billion trading loss, unleashing a new round of criticism against large U.S. banks and their trading practices.

Fisher has called for the breakup of the five largest U.S. banks, including JPMorgan, saying their size makes them a threat to the stability of the financial system. The biggest Texas-based banks, BBVA USA Bancshares and Comerica Inc, rank as 31st and 32nd biggest in the United States, according to data collected by the Federal Reserve.

On Friday at a Texas Bankers Association, Fisher declined to comment directly on JPMorgan's losses but cited the Dallas Fed's "tough stance" on all big banks.

"What concerns me is risk management, size, scope," Fisher said in answer to an audience question about the trading loss. "At what point do you get to the point that you don't know what's going on underneath you? That's the point where you've got too big."

Bankers should aim never to be on the front page of the newspapers, he said, unless it's for Rotary Club or other community work.

Fisher, an outspoken foe of further monetary policy easing by the Fed, also used the appearance to repeat his opposition to a third round of quantitative easing, known as QE3.

"I did not support QE2, and I will not support QE3, I made that clear," he said in answer to an audience question.

Known for trumpeting the merits of the Texas economy, Fisher heaped praise on his home-state banks, calling them "the nation's best-run."

In 2009, when the nation was reeling from the financial crisis, U.S. banks as a whole lost $11.5 billion; Texas banks earned $1.4 billion, he said.

One of the most widely used measures of credit quality at banks is still called the "Texas ratio," a name that dates from the late 1980s when Texas banks were among the worst in the nation. The higher the ratio, the worse the bank's credit.

The measure should be renamed the "anywhere but Texas ratio," Fisher said, noting that now less than 1 percent of Texas banks had a ratio of over 100 last year, compared to 4.6 nationwide, and 24 percent in Georgia.

(Reporting by Marice Richter; Writing by Ann Saphir; Editing by Neil Stempleman)

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Big isn't bad, banks tell Fed

By Dave Clarke

WASHINGTON (Reuters) - The largest U.S. banks are accusing the Federal Reserve of attempting to misuse its new regulatory powers to shrink financial giants under the misguided belief that "big is bad."

Lobbying groups representing the big banks are pushing back against a set of proposed rules the Fed issued in December to more closely scrutinize the firms and rein in their risk taking after the 2007-2009 financial crisis.

In a letter sent Friday, the groups said the Fed is going too far and is proposing a set of policies on credit exposure and capital standards that go against the intent of the 2010 Dodd-Frank financial oversight law.

"We submit that an approach grounded in a 'too big' or 'big is bad' concept is not only contrary to Congress' intent but is misguided and detrimental to a sound, strong banking system and a strong economy," the groups wrote.

The letter precedes a meeting next week between Fed Governor Daniel Tarullo and the CEOs of large banks, including JPMorgan's Jamie Dimon, according to a person familiar with the plan.

The meeting was scheduled to talk about the Fed's annual stress tests on the banks. The banks may try to press him on other issues including their qualms with the December proposal for managing large banks.

The letter was written by The Clearing House Association, the American Bankers Association, the Financial Services Forum, the Financial Services Roundtable and the Securities Industry and Financial Markets Association. Comments on the December proposal are due Monday.

The Dodd-Frank law requires the Fed to write rules for overseeing bank holding companies with more than $50 billion in assets to ensure they are not engaging in risky activities that could threaten the financial system.

The groups said the Fed "has set a course," however, to use these new powers "to achieve indirectly what it was not authorized to address directly - that is, precipitate a dramatic reduction in the size of large banks through size-based regulation."

Collectively the lobbying groups represent the largest U.S. banks, including Citigroup Inc (C), Bank of America Corp (BAC), JPMorgan Chase & Co (JPM), Goldman Sachs Group Inc (GS) and Wells Fargo & Co (WFC).

The salvo against the Fed is the latest example of tension over whether there are too many large banks whose potential failure poses a grave threat to the larger financial system.

Dallas Fed President Richard Fisher has taken a more extreme position, recently proposing breaking up the five biggest U.S. banks.

Tarullo, who has been the central bank's point man on regulation, has been more moderate.

He has never publicly called for breaking up the largest banks. But he has spooked the industry by questioning whether banks can get so big that any future growth does not provide value, through economies of scale, to the financial system or economy.

"It is possible that a firm would need to be quite large and diversified to achieve these economies, but still not as large and diversified as some of today's firms have become," he said in a September speech calling for more study of the issue.

In their letter, the groups argue that allowing banks of all sizes benefits the economy and that the largest institutions can provide services their smaller competitors can not.

"In the 21st century, companies served by international banks compete in a global economic system, exporting finished products, importing raw materials and components, and establishing substantial operations abroad," the groups wrote. "They need banks that are competitive around the world and are able to meet quickly and efficiently a wide range of financial needs."

The 161-page letter gets deep into the details of the rule and of particular concern to the banks is a Fed proposal to limit the credit exposure of big banks to a single counterparty as a percentage of the firm's regulatory capital.

The credit exposure between the largest of the big banks would be subject to an even tighter limit. A bank with more than $500 billion in consolidated assets could not have a credit exposure of more than 10 percent to another bank of that size.

The letter calls this proposal "unrealistic and one-dimensional" and that, among other things, it miscalculates the threats posed by exposure to derivative markets.

The groups also contend the Fed has offered no explanation for why the 10 percent threshold is necessary.

(Reporting By Dave Clarke; Editing by Andrew Hay)

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Fed solicits bids from eight banks for Maiden Lane III assets

NEW YORK (Reuters) - The New York Federal Reserve said on Wednesday it has asked eight dealers to bid on assets from its Maiden Lane III portfolio, which was created during the bailout of insurer American International Group (AIG).

Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and Nomura have been invited to submit bids for the assets, "based on the strength of their expressions of interest" in the bonds, the Fed said in a statement on its website.

BlackRock Solutions, the investment manager for the Maiden Lane portfolio, will conduct a bid process for the bonds, with all bids due on April 26, though there is no fixed timetable for the sales, the Fed said.

The Fed will decide whether to sell the assets based on the strength of the best bid, it said.

Maiden Lane III grew out of the purchase of $29.3 billion in collateralized debt obligations from certain counterparties to an AIG unit.

The Fed completed the sale of all the remaining securities from its Maiden Lane II portfolio in February, which had $20.5 billion worth of risky mortgage bonds owned by several AIG insurance subsidiaries.

The New York Fed held three auctions to sell the assets from Maiden Lane II. Credit Suisse Group AG bought roughly $13 billion worth of the Maiden II bonds, while Goldman Sachs purchased about $6.2 billion.

(Reporting By Karen Brettell and Richard Leong, editing by Dave Zimmerman)

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Judge dismisses claims against banks in GE lawsuit

By Nick Brown

NEW YORK (Reuters) - A federal judge on Wednesday dismissed claims against Goldman Sachs Group Inc (NYS:GS - News), JPMorgan Chase & Co (NYS:JPM - News) and 40 other defendants that they helped mislead investors in General Electric Co's $12.2 billion stock offering in 2008.

U.S. District Judge Denise Cote, who took over the case in February, said a January ruling denying the defendants' bid to dismiss claims failed to consider key court rulings and improperly relied on certain statements.

Cote's ruling does not entirely dismiss the class action lawsuit filed by GE investors, keeping intact claims that GE (NYS:GE - News) and its chief financial officer, Keith Sherin, made misleading statements about the quality of the company's loan portfolio.

The State Universities Retirement System of Illinois, the lead plaintiff, filed the lawsuit in 2009, saying GE and myriad financial firms were responsible for investor losses during a six-month period when GE's stock price fell to about $10 from about $26.

The plaintiffs alleged that GE withheld information regarding its health and the health of its GE Capital finance arm, including exposures to subprime and other low-quality loans. They also said GE misleadingly touted itself as being safer than rivals, despite the effects of the financial crisis.

Among those dismissed from the lawsuit on Wednesday are Barclays PLC (LSE:BARC.L - News), Citigroup (NYS:C) and Bank of America Corp (NYS:BAC - News).

"The January opinion improperly relied on statements that were not incorporated into the offering documents, and on statements that were modified and superseded by later statements," Cote said.

It also failed to take into account a court ruling that had established rules on whether stated opinions could be grounds for a lawsuit, Cote said.

Attorneys for the dismissed defendants did not respond to requests for comment. Lawyers for the plaintiffs could not immediately be reached.

A GE spokesman did not respond to an email seeking comment.

The case is In re: General Electric Co Securities Litigation, U.S. District Court, Southern District of New York, No. 09-01951.

(Additional reporting by Jonathan Stempel; Editing by Ryan Woo)

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Fed issues guidelines for banks converting homes

WASHINGTON (AP) -- The Federal Reserve has issued policy guidelines for banks turning foreclosed homes they own into rentals, a trend that could help boost falling home prices.

The central bank said Thursday that banks making the conversions should preserve needed documents and meet all federal, state and local laws that apply to renting.

Fed Chairman Ben Bernanke and other Fed officials have said that with home prices continuing to fall and rents rising, it makes sense for some foreclosed homes to be converted into rentals. Demand for rentals has grown since the housing meltdown.

Sales of millions of foreclosed homes are resuming since the government's settlement with the five biggest mortgage lenders over lending practices. Homes in foreclosure sell at a 20 percent discount on average.

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