How did Greece manipulate its debt accounts?

Posted on 22. Feb, 2010 by Jean Jacques Ohana in Weekly Focus | Comments Off

It has recently been revealed that Greece gamed the European Commission rule by maintaining artificially its Debt to GDP ratio below 60% for several years. In 2001, when Greece joined the single currency zone, it issued more than 10 Billions USD debt denominated in dollar and yen. It contracted a cross currency swap with Goldman Sachs aiming at hedging the currency risk embedded in the yen and dollar denominated debt payments.

Meanwhile, Goldman Sachs engineered a financial trick to help Greece optically reduce its publicly reported debt and deficit ratio. Whereas traditional currency swaps are valued at zero, by setting the foreign currency rate at the forward rate (the latter equals the spot rate adjusted from interest rates differentials between domestic country and foreign country), this swap set the currency rate at an artificially low EUR/USD rate (or EUR/JPY rate) to create an upfront payment from Goldman Sachs to Greece and increase future Greek debt payments.

Actually the swap turned into a disguised off balance sheet debt financed by Goldman Sachs as described by the chart below.

The structure enabled Greece to enhance its cash balance by 1 Bil USD in 2002 while masking the new off balance sheet debt. At this time, it accounted for around 0.7% of nominal GDP. The 1 Bil USD will be progressively paid out by Greece once the deferred debt arrives to maturity, probably between 2015 and 2020.

Of course, the swap does not change much of the Greek debt situation which went through an unsustainable path well before this “cheat” was made popular. But this affair raises a set of questions which will erode investors’ confidence.

How did Goldman Sachs manage to arrange the deal, make substantial profit margin from it, hedge the whole credit exposure (by buying insurance on the default of Greece) and eventually underwrite Greek debt issues without revealing the deal to investors?

This scandal highlights once more the conflicts of interest which still have not been resolved in the financial system. More investigations are required to know what exactly happened, but, if suspicions are confirmed, this kind of attitude from investment banks represents a problem in terms of ethics and poses a threat to the trust needed for the functioning of financial markets.

How many other countries execute similar derivatives window dressing operations? The rumor has it that Italy, Spain, Portugal have contracted similar structures with investment banks…

This situation, if not clarified promptly by the Governments and the European Commission may be a revival of the Enron accounting manipulation, which cast a doubt on the credibility of companies’ financial accounts and resulted in a major credit crisis in 2002.

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