The practice wasn’t secret and it wasn’t illegal, and some of it happened 10 or 15 years ago. But the practice of European governments reportedly using complex financial transactions to move debt off their books is getting closer attention from markets and the European Union.
The deals, known as swaps, let some governments shrink the apparent size of ther deficits, unsettling news at a time when markets are taking stock of Europe’s struggle with increased levels of government debt.
Greece has until Friday to disclose to the European Commission how it used complex currency swap deals and whether they were used to conceal the real scale of its debt - specifically a 2002 deal that Greek officials said they did with U.S. investment bank Goldman Sachs.
Under the deal, known as a currency swap, Greek dollar and yen debt was reportedly exchanged for euro debt for a period at an advantageous rate to be reversed at a later date. The effect was to show less debt in the near-term.
The deals carry some of the hallmarks of the financial crisis - such as off-balance sheet liabilities and highly complex financial arrangements.
Christine Lagarde, France’s finance minister, said the EU statistics agency Eurostat, would examine how Goldman Sachs “helped Greece structure, postpone a certain number of debt repayments.”
“You have to know first of all whether it was doctoring the accounts and if this was legal or not at the time it was done, and if it was legal, it will be necessary to find out whether it was favourable for stability. Probably not. And in that case, how we can avoid a repeat, if those measures already were taken,”
Greece wasn’t necessarily doing anything new - Italy did something similar in the 1990s while Belgium has also been mentioned by analysts as using financial derivatives to improved its reported fiscal position.
Professor Gustavo Piga of the University of Rome has warned for years that more and more governments were using the complex financial instruments that mushroomed during the 1990s.
Prof. Piga is amazed that in the nine years since he wrote an analysis about the growing involvement of governments in the derivatives markets that no one at the European Central Bank or Eurostat, the EU’s statistics office - even journalists - got in touch with him to discuss his findings.
However, he hopes that the current concern surrounding Greece’s deal with Goldman Sachs finally triggers belated reforms of this opaque practise.
Prof. Piga told The Associated Press that governments should not be banned from using trading in complex financial instruments as part of their debt managements - he said Sweden and Denmark appear to have done so in according with good practise. But such deals should be more transparent and comply with accounting standards.
“The scandal needs fixing; it was never done before but I hope it will be now,” said Prof. Piga. “This creates further confusion about the state of the accounts and investors will be asking higher risk premia as things start to unravel again.”
Greece’s dire debt situation has been the main driver in the markets over the last month or so as investors fret about the new Greek government’s ability to slash its budget deficit from 12.7 percent to 8.7 percent of GDP this year alone.
The former head of Greece’s public debt agency argues that it didn’t break the rules and that it wasn’t alone in employing novel financial instruments to manage its debts.
Christopher Sardelis, the head of Greece’s Public Debt Management Agency from 1999 to 2004, slammed suggestions that the debt refinancing operation with Goldman Sachs was meant to mask the country’s debt and insisted that it was conducted in accordance to then-existing EU accounting rules - through the deal, Greece is thought to have booked a near $1 billion profit, used to neatly trim the deficit.
“Since 2002, when the rules changed, securitizations and swaps have been recorded as part of the public debt,” said Mr. Sardelis.
Though Greece insists it has been playing by the rules, the swap deals still require servicing at some point - the Commission will hope to get details on this on Friday. This could be costly to the country, further undermining the government’s ability to get a grip on its public finances.
A February 1 report commissioned by the Greek finance ministry warned of “significant debt revisions” for 2009 partly because of the swaps.
Greece isn’t the only party in the line of fire - there are growing calls for the banks themselves to face an investigation in a much wider probe.
Simon Johnson, an economics professor at the MIT Sloan School Management and a former chief economist at the International Monetary Fund, thinks the Commission should launch a special audit of Goldman Sachs and all its European clients going back to the start of the euro in 1999, and that the U.S. Federal Reserve should cooperate with the investigation.
“If this were the U.S., they would get a gentle tap on the wrist but in Europe, they’re more skeptical about big banks,” he said. Goldman Sachs was “aiding and abetting” efforts to undermine the single currency rules, said Prof. Johnson.
Goldman Sachs officials had no immediate comment.
Prof. Johnson said an audit is crucial if European policymakers are going to design a better framework to help out weaker euro-zone economies in the future.