As share prices plunged and bond spreads soared in Italy late last week,  ministers were tinkering with the €45 billion budget package and threatening to a mountain of amendments before it even hit the floor of the Senate.

The European Central Bank, which has been buying Italian bonds since early August, urged the government to stand firm on its pledge to balance the budget by 2013, as the trade unions planned a national strike to protest against the proposed cutbacks tomorrow.

But Italian Prime Minister Silvio Berlusconi had other things on his mind.

Just when it seemed there was nothing else he could do to surprise us, the s-x scandal that has dogged the 74-year-old billionaire for the past two years was explosively reignited.

Giampaolo Tarantini, the businessman who previously admitted paying escorts to attend Berlusconi’s notorious s-x parties at his residence in Rome and luxury villa in Sardinia, was arrested with his wife, Angela Devenuto, for alleged extortion of the prime minister.

Acting on arrest warrants issued by a Naples judge, investigators from Digos, the police agency charged with fighting organised crime, detained Tarantini and his 34-year-old wife in Rome last Thursday before transferring both to separate prisons in Naples.

A second man, Valter Lavitola, director of the online daily, Avanti!,  and apparent confidante of the prime minister,  is also implicated in the alleged extortion.  He is believed to be abroad.

Telephone intercepts recorded by Naples prosecutors claimed that Berlusconi paid Tarantini €500,000 as well as €20,000 in monthly expenses  to deter him from releasing embarrassing, taped telephone conversations  and  for telling investigators the PM was not aware the women were prostitutes.

After Tarantini and his wife were interviewed by prosecutors on Saturday it emerged that the prime minister is alleged to have paid as much as €800,000 since November 2010.

Tarantini denied that this was extortion and that the prime minister had simply offered to help him out of financial difficulty — not because he was under threat.

“He took our problems to heart,” Angela Devenuto told prosecutors. “He treated us like a father, an uncle. He felt a little bit like a grandpa to our kids.”

Tarantini added: “The prime minister wanted to help us.”

Berlusconi is currently being tried in a Milan court on charges that he paid for s-x with an underage prostitute known as Ruby Rubacuori and then used his position to cover it up.   Both he and the woman deny the allegations.

The prime minister has always denied paying for s-x and it is the core of his defence at his trial, which will resume in October.

But on July 5 prosecutors taped Tarantini speaking to his colleague Lavitola.

“There are telephone calls between me and the girls, in which they tell me that he gave them money the previous day,” Tarantini allegedly said.

Tarantini , who was convicted of cocaine trafficking in June,  was the man who introduced Bari escort Patrizia D’Addario to the prime minister in 2008. She made world headlines a year later with the release of taped conversations allegedly recorded while she was having s-x with Berlusconi at his Rome residence.

But Berlusconi has dismissed the Naples investigation as “pure fantasy”.

“I gave a hand to a family with children and I do it as it happens with a number of people,” Berlusconi said on Thursday.  “I do it because I can.”

There were predictable reactions from Berlusconi’s political opponents.  “Escorts, escort procurers and organising parties  are activities that no democracy in the world would tolerate in a premier,” said Luigi Zanda, from the opposition Democratic Party. “We have an international image as a country governed by a clown.”

But the left-leaning La Repubblica newspaper said the prime minister’s personal weakness for women had turned him into an “ATM” because he was so vulnerable to blackmail. Columnist Liana Milella said this was the worst chapter in the prime minister’s messy private life and his kind-hearted defence did not stand up.

“Fair enough you can call Italy the land of Pinocchio,” wrote Liana Milella on Sunday. “But there is a limit in how much you can believe in fairytales.”