Goldman’s Trojan currency swap | FT Alphaville

Goldman’s Trojan currency swap

A curious game of Maastricht criteria hide-and-seek

The Spiegel is reporting that Goldman Sachs helped Greece cover up part of its whopping deficit. The deal was reportedly done via a currency swap, using artificially high exchange rates.

Here’s the relevant bit of the report:

Greece’s debt managers agreed a huge deal with the savvy bankers of US investment bank Goldman Sachs at the start of 2002. The deal involved so-called cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period — to be exchanged back into the original currencies at a later date.

Such transactions are part of normal government refinancing. Europe’s governments obtain funds from investors around the world by issuing bonds in yen, dollar or Swiss francs. But they need euros to pay their daily bills. Years later the bonds are repaid in the original foreign denominations.

But in the Greek case the US bankers devised a special kind of swap with fictional exchange rates. That enabled Greece to receive a far higher sum than the actual euro market value of 10 billion dollars or yen. In that way Goldman Sachs secretly arranged additional credit of up to $1 billion for the Greeks.

The loan-cum-currency swap would not have shown up in Greece’s debt statistics, which means it was effectively a way of bypassing the eurozone’s Maastricht criteria, which prescribe certain debt-to-GDP metrics for countries wishing to join the single currency zone.

Even with the currency swap, we should note, Greece’s finances have never quite been Maastricht-compliant. Only once in the past 20 years, for instance, has Greece found itself in keeping with the EU edict that fiscal deficits should not exceed 3 per cent of GDP (in 2006).

In any case, Greece’s previous fiscal shortcomings are now well known. The issue is that, as the Spiegel notes, at some point the country will have to pay up for its swap transactions, and that will impact its (current) deficit. The bonds reportedly mature sometime between 2012-2017.

Interestingly, this is not the first time such a currency swap has been used in this way.

The last instance was another porcine-acronym eurozone peripheral country: Italy.

From a 2001 Euromoney article:

In May 1995, Italy issued a Y200 billion ($1.6 billion) bond. The exchange rate at that time was Y19.30 to the lira. By December 1996, the yen had depreciated to Y13.40 against the lira. With 12 European countries desperately trying to meet the five criteria for joining the single currency, Italy wanted to hedge its foreign exchange gains, so it entered into a currency swap with a foreign bank.

But the swap had some peculiar features. The rate on the swap was Y19.30 to the lira, the exchange rate at the time of the bond issue. This was unusual – the vast majority of currency swaps are done at the existing currency rate, as Eurostat, the European Union’s statistics office, admits. The exchange rate was far worse than Italy could have obtained. It was losing a lot of money in the long term.

Also unusual was the interest rate on the swap – Libor minus 1,677 basis points. Such an interest rate was almost unheard of in the currency swap market. It meant the bank counterparty was paying Italy cash advances through quarterly payments.

You can see how the swap might be more of a loan than a currency hedge for Italy’s Euro-yen bonds. The country effectively would have received four cash advances because of the negative interest rate from the unnamed bank counterparty.

Italy, we should note, always insisted the swap was just a way to lock-in foreign currency gains. Furthermore, they say, the thing would only have reduced the country’s debt by 0.02 per cent — not enough to make a difference for Italy’s eurozone-ambitions.

But there was the suggestion the swap was just one part of a series:

… these deals are usually part of a series and it is probable this was the case with the swap … If there were 10 of them, the cash from the deals would be enough to reduce the country’s debt by 0.2%, which was close to the amount Italy needed to reduce its deficit to GDP ratio in 1997.

Greece’s currency swap reportedly took place around 2002 — a year after the country joined the eurozone. In that respect it’s perhaps even more of a mystery than Italy’s.

Why did the country feel the need to fudge its deficit in 2002 specifically?

And why did Goldman Sachs reportedly want to help it do so?

The Spiegel report has a clue, at least on the Goldman point:

Goldman Sachs charged a hefty commission for the deal and sold the swaps on to a Greek bank in 2005.

Ouzo all around then.

Well, at least for Goldman, if not the Greek banks.

Related links:
The ever increasing parallels between AIG and Greece – ZeroHedge
How do you say vicious circle in Greek? – FT Alphaville