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Greece and Goldman Sachs

Investigative reports by the New York Times and Der Spiegel have left Goldman Sachs and Greece squirming in the limelight. For at least fifteen years, the American investment bank has been helping Greece legally massage its public finances. The arrangement enabled Greece to keep its European partners happy without having to make tough fiscal decisions. Specifically, the bank created currency swaps that enabled debt issued in dollars or yen to be swapped for euro-denominated bonds that would be paid back at a later date. Sound fishy? Those on both sides of the Atlantic think so. From the New York Times:

Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.... Wall Street did not create Europe’s debt problem. But bankers enabled Greece and others to borrow beyond their means, in deals that were perfectly legal. Few rules govern how nations can borrow the money they need for expenses like the military and health care. The market for sovereign debt — the Wall Street term for loans to governments — is as unfettered as it is vast.

Der Spiegel has been following the issue for a longer period of time, and the frustration in Germany over Greece's behavior is particularly acute. The magazine notes that the accounting procedures have only delayed the day of reckoning:

At some point Greece will have to pay up for its swap transactions, and that will impact its deficit. The bond maturities range between 10 and 15 years. Goldman Sachs charged a hefty commission for the deal and sold the swaps on to a Greek bank in 2005.

The activities of Goldman Sachs in Greece are neither surprising nor novel. Indeed, Der Spiegel notes that Italy has engaged in similar activities with another bank for some time. The controversy highlights how difficult fiscal reform is in modern democracies. Today was Greece's day of reckoning, tomorrow could be America's. Anne Applebaum at Slate writes, "I have seen America's future and it is Greece."

The revelations come at a very inopportune time for Greece, the bank, and the EU. What do these revelations say about the proposed bailout of the country by the EU? Can the Euro survive when its member states can easily fabricate their numbers? (Imagine California making secret purchases in eurobond markets that are swapped out at a later date for dollar-denominated bonds.) Is the Euro feasible without greater political cohesion among the EU's member states? And what does this transaction say about the value-added of investment banks? As Baseline Scenario notes, are investment banks in sovereign markets really producing "productivity-enhancing financial innovation" or just "a sophisticated form of scam?"


There is a significant amount of hand-wringing going on in the US that the Euro is fraying on the edges. Some pundits have even coined a rather derogatory acronym for Euro-countries in economic distress: the PIGS (Portugal, Italy or Ireland, Greece, Spain). The acronym bunches together four countries with very different backgrounds but one shared fact: they all face serious budget shortfalls.

The grouping of these countries, largely by investment banks, may simplify investment and policymaking decisions to an unfortunate level. Italy for one does not want to be part of the group, and the Italian bank UniCredit has waged an effective campaign to change the "I" in PIGS to Ireland. But Ireland too has begun to restore both consumer confidence and budget stability thanks to aggressive action by the central government. Commentators seem to keep the "I" because that is the crucial vowel that holds the acronym together.

Portugal, Spain, and Greece are also all facing very different challenges. Portugal has a sizable but manageable budget deficit, while Spain is struggling with a burst housing bubble a la Florida. Greece remains the real country of concern; but then again, Greece has roughly the same debt levels as Germany, so what is all the fuss about?

The classification overlooks the more important--and legally binding---organizations already in existence, namely the EU and the Eurozone. Talk of the dissolution of the Euro is premature but rampant: the New York Times has published no less than three articles on the subject in the last two days alone (here, here, and here). At the end of the day, policymakers in Europe and the US have to honestly ask themselves: is leaving the Euro really an option? The case of Iceland clearly demonstrates what happens to small countries with large debt obligations in tumultuous times and it is not pretty.

The discussion of categorization reminds me of the BRIC acronym held in high regard by investors prior to 2008. Brazil, Russia, India, and China were touted as the hallmarks of the developing world at the time, and investments in all four countries were seen to be equally appeasing. Two years, a war in Georgia, and a global economic crisis later, the BRICs no longer look so homogeneous. I suspect the same will soon be true for the PIGS. 

How should we classify countries economically? Is there any value in
grouping problem areas? Just as a reference, I did a quick look at state budgets in the US and found five states with budget deficits greater than 10% in 2009: Arizona, California, Nevada, New Jersey, Rhode Island. Do you think CARINN could catch?

The ECB Plays the Role of Scrooge

"What's Christmas time...but a time for paying bills without money?" - Ebeneezer Scrooge in A Christmas Carol by Charles Dickens

The European Central Bank has no plans to bail out Greece if it encounters difficulty in meeting its debt obligations. According to the Wall Street Journal Bank member Ewald Nowotny said,  "One has to be very clear: The ECB has no mandate or intention to take into account the situation of a specific country, especially not with regard to public finances." In other words, "if the poor would rather die, they had better do it, and decrease the surplus population."

The bank's reasoning is understandable: a blanket guarantee to underwrite sovereign debt throughout Europe would create an untenable moral hazard. And the bank likely does not have the legal foundation to "bail out" a sovereign country. But Greece has gone through a spate of bad news: First, Fitch and then S&P downgraded Greece's credit rating to BBB+. Moody remains the only rating agency to give the country an A1 grade, but it has the country on a negative watch. They would certainly have appreciated some good tidings.

Goldman Sachs analyst Erik Nielsen notes how this news creates a strange situation for the bank and for Europe (from Bloomberg News):
This is a bizarre and ultimately untenable situation for the ECB....The unthinkable -- that the ECB would not accept sovereign securities form a member as collateral -- has become a measurable risk, and one exclusively controlled by Moody's....Moody's is now the de facto decision maker on Greek eligibility.
A European institution (the ECB) refuses to entertain the idea of helping Greece, and so everything rests on an American company (Moody's). Merry Christmas Greece? Bah humbug!