Pointing the Finger at Wall Street and Irresponsible Governments

The Financial World According to Inya” Column
by Inya Ivkovic, MA

The strategy of beautifying European governments’ balance sheets with complex derivatives is creating quite a furor among investors, with all fingers pointing at Wall Street and irresponsible governments around the world. Actually, at the heart of it all appears one particular firm, Goldman Sachs, which helped one particular EU country, Greece, back in 2001 to camouflage, albeit perfectly legally, the country’s enormous debt through executing off-balance sheet (or hiding in plain sight) swap transactions. Few people understood these derivatives, and certainly not the ones who authorized them. Now, Greece is trying to survive under the severe pressure of a full- blown debt crisis, a situation that is further exacerbated by severe skepticism about the country’s bookkeeping methodology.

Greece is not the only one in the hot seat. Goldman Sachs is facing just as much criticism, if not more, to the point of having to resort to the unusual step of posting a statement on its web site a few days ago, describing what swaps are and focusing particularly on clarifying that whatever Goldman Sachs did for Greece and other European countries was not illegal or inconsistent with European accounting principles at the time.

Moreover, things have gone as far as a senior Goldman Sachs executive having to appear before the British parliamentary committee and explain that, while his firm’s swap transactions were not inappropriate, the transparency of transactions left much to be desired. Of course, all this defensiveness is not likely to quiet down the critics or gloss over the controversy, because Greece is not the only country where Wall Street has meddled. A series of other swap transactions with other European countries, from Portugal to Italy, is coming under intense scrutiny as well.

At the same time, investors around the globe are still licking their wounds inflicted by the credit and financial crisis. Finding out about more devastation caused by murky derivative transactions and the Wall Street firms that peddled them is not being digested well. Even if the deals did not involve large amounts of money, the effect of eroded confidence in European governments’ finances represents a dangerous conundrum.

Reactions of those directly impacted vary. Greece, for example, is trying to sell its bonds, but its efforts are not exactly landing on fertile ground. It is not so much the complexity of derivative transactions that cannot be explained away, as it is the questionable practice of the public sector not being transparent and truthful about its finances, which makes people extremely uneasy about what else their governments are hiding.

It seems there is much doubt concerning the trustworthiness of financial statements of governments sharing the euro. Countries belonging to the European Union are expected to stay under specific targets for debt and deficits had to demonstrate the degree of fiscal responsibility. However, short of the real deal, Greece had to tweak its numbers a bit to show the EU that it will have no problem meeting these targets. And now it finds itself with a deficit that is 12.7% of its GDP, which is more than four times the target other EU countries are using.

Helping “tweak” the numbers was Goldman Sachs, the Wall Street bank that structured the deal with Greece, first with a series of relatively ordinary currency swaps to manage the risk of fast-fluctuating exchange rates. The idea behind currency swaps is to allow counterparties to exchange one currency for another at regular intervals and at an agreed-upon rate. The problem was, however, that these swaps were also accounted on and off books often at far too favorable a rate, which had the effect of making the debt look smaller than it actually was. To illustrate, swaps that Greece and Goldman structured in December 2000 and June 2001 booked a very favorable exchange rate, which reduced Greece’s liabilities by approximately 2.4 million euros. For the favor, Goldman Sachs collected about 300 million dollars in various fees.

Is it any wonder that investors are so angry with Wall Street and irresponsible governments? Of course not. The 300-million-dollar question is: what are we going to do about it?