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A Stark Warning: Greece, Goldman Sachs and the ‘Swaps Deal’

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About The Author

Konstantina Litsiou (Guest Contributor)

Konstantina is a law graduate from the University of Sussex who has recently obtained an LLM in international financial law. She has worked as a legal secretary and is currently working as a legal trainee in a Cypriot Law Firm. Her main areas of interest are financial, commercial and shipping law. Outside the law, Konstantina enjoys photography and travelling.

Let's stop kidding ourselves that Greek debt is the Euro's key problem. With Greece gone, who's next?

Alex Morritt

In simple terms, a derivative transaction is a special type of contract, whereby two parties agree to buy or sell certain goods – typically bonds or other debt instruments – for a set price on a set date. In 2010, it became public knowledge that – with the help Goldman Sachs – Greece had entered into derivatives transactions that were enabling them to disguise their debts and circumvent rules set down by the Maastricht Treaty.

In this case, the parties agreed so-called ‘currency swaps’: Greece issued debts in dollars and yen that was swapped for debts in euros. Similar agreements have occurred across the rest of Europe for many years: it is common for countries to secure funds from investors from around the world by issuing debts to banks in a wide range of currencies that will be repaid later. Such transactions are part of normal government refinancing.

However, in the derivative transactions upon which this article focuses, fictional exchange rates were used and the amount of money exchanged was ‘kept off the books.’ This meant that Greece earned far greater sums for their debts than they would have done had the market value been applied. Therefore, the Greeks were able to hide the extent of the country’s national debt for the period of time during which the transactions were in operation.

This deal has been widely criticised and has triggered a number of problems that the Greek government – when initially entering into the transaction – seemed not to have anticipated. Some will impact on the financial security of the country and its population; others, however, have greater implications that will be felt right across Europe. This article shall examine the transaction, scrutinising how the Greek government got itself into this situation, how the deals were structured and whether such revelations should trigger the introduction of regulatory reforms in the derivatives market by the EU or by individual Member States.

How Greece Got There

Sovereign debt – and the difficulties of its repayment – have long been an issue in Greek politics. After having undergone an ‘economic miracle’ between 1950 and 1973, during which it recorded an average Gross Domestic Product (GDP) growth of 7% a, a sharp recession after the oil crisis of 1973 triggered a sharp recession and high inflation. And, with the country struggled to tame inflation, a second oil price shock in 1979 heralded swift changes as the populist left-wing Pan-Hellenic Socialist Movement (PASOK) party won the elections of 1981.

PASOK borrowed heavily to finance its populist programme of state spending that was aimed at improving the standard of living of the Greek population. Though well-intentioned, this change in economic policy saw Greece’s debt-to-GDP ratio balloon. Combined with the decline triggered by the oil price shock, the government were forced to borrow more to reduce its public sector deficits. By 1993, Greece’s debt levels reached 100% of GDP.

This would leave Greece unable to comply with the conditions of entry for the Eurozone: the Maastricht Treaty, which came into effect in 1992, only permitted countries with – among others things – a budget deficit below 3% of GDP and sovereign debt that did not exceed 60% of its GDP. This meant that following the birth of the Eurozone on 1 January 1999 – when the currency operated alongside existing national currencies – Greece was left watching on from the sidelines.

On Comes the Camouflage

It was clear that the health of the Greece’s economy was such that it would be unlikely to meet the conditions stipulated by the Maastricht Treaty for the foreseeable future. It faced a seemingly Herculean task to bring about the necessary changes. However, in the late 1990s, the figures that the Greek government submitted to EU’s authorities showed that it was on track to comply with all the conditions. In 2000, with Greece’s deficit reported to be below 3% for the previous year, Greece was accepted as the 12th member of the Eurozone. Another economic miracle seemed to have occurred, and in his televised New Year address, the Greek Prime Minister declared that:

Our country is already experiencing euro conditions. We all know that our inclusion in EMU ensures for us greater stability and opens up new horizons.

It is unknown whether EU officials were aware that Greece was only giving the impression that its economy had magically transformed. What has been confirmed, however, is that during the early years of its membership of the Eurozone, the Greek government was desperately searching for ways to camouflage its true economic figures – particularly, the extent of its sovereign debt.

The Swaps Deals

The Terms of the Deals

An effective, albeit temporary, solution showed up thanks to the economic ingenuity of Goldman Sachs, a powerful US bank. Goldman Sachs offered to assist Greece with concealing enough of its debtso as to appear to satisfy the conditions imposed by the Maastricht Treaty. In 2001, the Greek government entered into complicated derivative transactions with the US bank: 13 swap contracts set out the arrangements for exchanging Greece’s debt – issued in yen and dollars (one also involved the use of Swiss Francs) – for euros.

These transactions were not based on the market rates for the different currency; instead, an ‘off-market’ exchange ratewas used that was more advantageous to Greece. As a result, for all intents and purpose, the country’s debt appeared to have decreased by 2.8 billion euros.

The obligations under the swaps were uneven. Because the Greek government could not afford to compensate Goldman Sachs immediately, the interest rate swap involved a two-year grace period before subsequent net interest payments kicked in. These payments were small, and to be paid annually until 2019. As a result, Greece’s debt would show up gradually, allowing the country’s officials to continue to disguise the extent of the country’s debt from the Eurozone.

However, after the attacks on the World Trade Centre in September 2001, bond yields plunged. This had a negative impact on Greece’s ability to meet the interest payments: by 2005, it owed almost double what it had put into the deal. Its off-the-books debt from 2.8 billion euros to 5.1 billion. For this reason, a major restructuring of the agreement with Goldman Sachs and Greece occurred in 2005: the maturity period was increased by approximately 20 years, the interest rates of the contracts were revised and the overall amount owed was locked-in.  Almost simultaneously, Goldman Sachs sold the bond containing the benefits of the contracts to the National Bank of Greece for its exact market value.

The Reaction to Discovery

The transactions were discovered in 2010. After a thorough examination of their terms and effects, one of the EU’s regulatory bodies – Eurostat – concluded that the swap contracts had been created for the purpose of decreasing the Greek government’s debt in foreign currencies. It asked for an adjustment of Greece’s deficit amounts so it could get an accurate picture of the country’s actual economic health.

Surprisingly, neither party was punished for their actions. While neither Greece nor Goldman Sachs had disclosed information about the transactions before the bond was sold, no elements of the deals were found to be unlawful. Officials from the bank and the Greek government avoided any penalty. Indeed, the chairman of Goldman Sachs USA – the holding company of the bank – was quick to observe to the House of Commons’ Treasury Committee that the transactions:

[W]ere very much consistent and comparable with the standards and behaviour of measurements used by the European Community [at the time].

He was correct: it was not until 2008 that EU law prevented Member States from using artificial rates in swaps to conceal their debts with the assistance of financial institutions. Indeed, similar transactions had been entered into by other countries seeking to join the Eurozone– in 1990, Italy had enlisted JP Morgan to mask its debt in a similar manner.

Were Either of the Parties to Blame?

The transactions were heavily criticized by politicians and economic commentators from across the world. Some attacked the Greek government, arguing that the onerous obligations under the contracts had been irresponsibly entered into, and had brought financial troubles for its taxpayers that it could neither pay back nor justify. Others, meanwhile, attacked Goldman Sachs for taking advantage of Greece’s financial situation for its own gain; the bank reportedly earned $793 million for its role in coordinating the transactions. Angela Merkel, the Chancellor of Germany said that:

It's a scandal if it turn[s] out that the same banks that brought us to the brink of the abyss helped to fake the statistics.

Arguably, neither party can take all of the blame. In defence of the Greek government, it might be pointed out that the country was in such financial difficulties – and therefore understandably desperate to secure Eurozone membership – that it was fair that it should take such a risk, particularly one that was technically legal. It might also plead the defence of ignorance, even if it risks looking negligent: the complex nature of the deals means official were unlikely to have had the proper knowledge to appreciate what the banks were offering it.

Meanwhile, from Goldman Sachs’ perspective, it should be observed that the bank was simply engaging in business. As it had every right to do, it seized upon the fact that Greece was willing to enter into such transactions with banks in order to hide their financial situation. No bank would likely to turn down the opportunity to enter into such profitable and lawful transactions.

Were There Any Legislative Changes?

When the European System of Accounts 1995 (ESA 1995) – which outlined the rules governing the Eurozone – had initially been approved, such transactions were not common. For that reason, no specific rules controlling their use were in existence.

In response to the revelations of the Greek-Goldman Sachs transactions, Eurostat and the European Union Statistical Community formulated detailed and precise Guidance Notes for the documentation of the securities operations of governments and for the use of financial derivatives.  The Guidance Notes considered an appropriate approach for keeping financial accounts under the ESA 1995, and placed limits on some particular derivatives transactions in order to secure suitable and uniform reporting of government debt and deficits across Member States.

Part IV of the Guidance Notes specifically provide that any amount of money exchanged at the beginning of the off-market swap will be characterized as loan. payments in advance rather than as a lump sum. It was by treating the sums advanced as ‘lump suns’ that countries had been able to disguise the extent of their debt. Charactering the amount as a loan would allow the transactions to be divided in a way which recorded the true extent of the obligations that the country had incurred.

A review of the Greek’s statistical system was undertaken by the European Commission. In reporting its findings, it identified a wide range of technical flaws that needed to be resolved, including:

[P]roblems stemming from statistical shortcoming related to methodological weaknesses and unsatisfactory technical procedures in the Greek statistical institute and in several other units that provide it with data such as the General Accounting Office and the Ministry of Finance, operational shortcomings of Greek institutions.

These shortcomings were attributed to governance issues such as limited collaboration, unclear responsibilities, dubious empowerment of officers and lack of written guidelines and records. The Commission therefore advocated new practices and the introduction of a new institutional framework that would secure the autonomy and accountability of the organisations tasked with the reporting of public debt and deficits.

The Greek authorities responded by reforming their statistical system: in March 2010, the Greek government passed legislation that established an autonomous statistical authority, ELSTAT. One month later, it produced an action plan in collaboration with Eurostat with the aim of ensuring effective improvement of the governance of the new statistical system that looked to improve the collection of statistics on government finances.

Various steps were taken to implement the new legislation. They proved a success: the appropriate recording of the swap transactions resulted in a documented 2.3% increase of Greece’s debt.

An Unresolved Question: Did the EU Know Something?

Though much of the blame for the transactions can arguably be shared between Greece and Goldman Sachs, it is worth noting that EU and Eurostat were accused of knowing beforehand about derivative transactions of its Member States. The potential existence of such transactions was also no secret: in 2001, they were  the subject of fierce debate after Professor Gustavo Piga of the University of Rome published a paper accusing Eurozone countries of ‘window dressing’ their public accounts using derivatives in exactly the same manner as Greece were discovered to be.

Furthermore, in November 2012, the European Court of Justice (ECJ) denied a freedom-of-information request by the news agency Bloomberg, which had requested access to two documents, one of which was intriguingly named ‘The Impact on Government Deficit and Debt from the Off-Market Swaps: The Greek Case’.The European Central Bank (ECB) had previously refused Bloomberg access to the documents on the grounds of the need to safeguarding the public interest. The ECJ held that the ECB’s ‘wide discretion’ in relation to the disclosure of documents meant that it had the right to ignore Bloomberg’s request.


The story of Greece and Goldman Sachs is but one example of the impact of the expansion of the derivatives market. Many governments have long (over)used derivatives to boost liquidity and to speculate. Before the Greece-Goldman Sachs deal sparked rule changes, several others had used such transactions to ‘window-dress’ their accounts and accomplish temporary political goals.

In the view of Gustavo Piga, these transactions raise a number of serious concerns. For one thing, on a wider scale, the ‘window-dressing’ technique may result in political and economic instability within the Eurozone. And, for the citizens of the countries like Greece, it is unfortunate that these transactions invariably result in their country being worse off in a way that tends to place a considerable burden on taxpayers. Furthermore, Gustavo Piga pointed out that the secrecy in which the transactions are shrouded must not be overlooked. He rhetorically asked:

What kind of relationships start to arise between these governments and these banks once they are in this mortal embrace of reciprocal blackmail potential? How does this change the dynamics on other issues, such as the regulation of banks?

As far as the future is concerned, it is clear that governments need to employ comprehensive and coherent rules on the accounting of derivatives. Whilst the benefits of financial innovation may appear to be exceptionally attractive to governments, the use of such practices requires suitable mechanisms for controlling and supervision the recording of financial accounts. Otherwise, they risk being caught by the samehazards in which Greece got trapped.

Financial innovation tends to move faster than the regulators. Therefore, harmonisation must be prioritized by the Commission: a supranational service comprising of advisers who specialise in such transactions should be appointed and tasked with examining the suitable accounting procedures for tackling them. A lot more needs be done in order: fortunately, the case of Greece and Goldman Sachs should be construed as a warning of what might occur if progress is not made.

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Tagged: Banking & Finance, Commercial Awareness, Commercial Law, European Union, Legal Business, Regulators

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