About This Whole Goldman Sachs–Greece Thing

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Photo: Navin 75 Flickr via CC BY-SA 2.0

This week, Goldman Sachs won the dubious distinction of being the first thing that has united Europe in the past 50 years, or maybe ever. Politicians in the European Union, including those from Greece, Italy, France, and others, jumped at the chance, in unison, to blame Goldman Sachs for their countries' disastrously mismanaged finances, long-lost derivatives deals, and leaving the toilet seat up that one time. The Daily Telegraph in London even ran an article claiming that Italians think their country is controlled by Goldman Sachs — an impressive allegation coming from a nation that created the Mafia, and whose top politician, Silvio Berlusconi, also owns most of the television stations. (There are a lot of people and things waiting in line in the "controlling Italy" queue ahead of Goldman Sachs, is what we're saying.)

Still. The discussion of Greece and Goldman Sachs and derivatives is the kind of thing that gives you that sinking feeling of being barely informed and even less interested. So, as a public service, Daily Intel is providing you with a handy guide to the situation, just in case it comes up.

How did this all get started? Greece has been steadily falling deeper in debt for the past decade, because of general irresponsibility but also because of things like paying for the Athens Olympics. Greece also did very little to pay down its debt when times were good. In December, Greece announced it was in the hole to the tune of 30 billion euros, or 12.7 percent of the value of all the goods and services the country produces. The European Union started to freak out almost immediately and demanded that Greece cut pay for all its state workers. Greece refused. Greece's troubles worried the European Union for several reasons. The biggest one is that if Greece defaulted, the euro would be worth less. According to EU rules, though, default is the only answer, because the consortium can't give any country money to save its own finances. And default is a pretty bad scene: Russia defaulted and nearly brought down the entire world's banking system. Argentina defaulted, and citizens stormed the ATMs. At the same time, Greece's troubles were imitated and magnified by a whole bunch of other European countries: Portugal, Italy, Ireland, and Spain. Together, these troubled countries are called PIIGs (yes, pronounced PIGS). So the EU is facing a tough choice: break its rules and bail out Greece; or refuse to bail out Greece and then see it go down and the other PIIGs down with it, creating a vast European economic emergency.

So how did Goldman get involved? In 2001, the bank helped Greece structure some complicated deals to help the country manage its debt. Goldman didn't invent the swaps; they were pretty common, and Italy as well as other countries used them, too. In fact, the deals were indirectly blessed by Eurostat, the statistics watchdog of the European Union, which included similar deals in its official handbook, according to Risk Magazine. Essentially, Greece called Goldman to create a way to delay and reduce the heavy interest payments on Greece's debt. Goldman's solution was to create currency swaps, which are deals in which a country or company will pay its debt in cheaper currency for a while. (The Wall Street Journal has a nice explainer here.) These swaps were completely legal. Greece and the ratings agencies approved Goldman's swaps. The only people who were not fully informed were investors: Greece didn't disclose the swaps in an official prospectus, Bloomberg noted, but that's because they weren't required to. The country did mention the swaps in its budget and told its parliament, though, according to The Wall Street Journal. Right now, scrutiny is pointed at Italy, which did similar swaps.

Wait, 2001? Yes. Greece hasn't done any of these swaps since 2001, and even rejected a proposal to do it in 2009. It's old news. In 2001, the Economist wrote an article about Italy gaming the system with similar swaps, and Risk Magazine wrote the definitive account of the Greek swaps back in 2003. It's fair to say that no one cared for the following seven years — until the current crisis caused Germany's Der Spiegel to do some Googling. Der Spiegel ran an article heavily based on the 2003 Risk article, and that set a number of big publications — "Greek woes revive seven-year-old swaps story."

Well, are these swaps evil? To paraphrase Bill Clinton, it depends on what your definition of "is" is. They don't look fabulous now that Greece is on the verge of default because it mismanaged its debt. But the swaps weren't illegal, and Goldman was giving its client — Greece — what it asked for. The bank followed all the rules to do it. True, the swaps weren't disclosed, but you can blame the Maastricht rules for that: No country has to disclose these swaps, and that's partly why they're so popular with politicians and also why you never hear about them in the popular media. The trend recently has been to slap down regulations on stuff that was okay before but looks bad now, and several countries including France have officials looking at these swaps for that reason.

So is this entire thing mostly political? Need you even ask?

Whew! Glad it can't happen here. Don't be so sure. Most countries like to avoid talking about the size of their deficits, and they like to make the deficits look smaller so that they can keep issuing government bonds without paying a lot to borrow the money from investors. Government bonds pay for things like infrastructure, schools, public transportation — and more recently, bailouts. In fact, the entire U.S. bailout of the financial system is funded by a weird government-bond-buying circle that makes it hard to track our debt: The Federal Reserve created the financial-system bailouts, then Treasury issues bonds to pay for the bailouts, and the Fed buys the Treasuries to pay for the bailouts, which, you'll remember, the Fed created. Then there's Fannie Mae and Freddie Mac, which are wards of the state. The Fed has been the biggest buyer of Fannie Mae and Freddie Mac bonds in order to prop up the housing market; banks, knowing this, spent much of the year buying up Fannie Mae and Freddie Mac bonds to sell back to the government at a higher price, knowing the Fed would pay through the nose if necessary. Almost certainly, the Fed has paid more than it has to for some of these bonds because it is the main buyer in the market. In addition, Fannie and Freddie keep sinking into debt, but our government has ruled to exclude the two disastrous companies from our national deficit — no small matter when Fannie and Freddie have something like $6.3 trillion in liabilities. Then there's California, whose disastrous finances could bring the entire country down, according to an op-ed in the Los Angeles Times. Recently, Moody's Investor Service warned the U.S. that its vaunted triple-A credit rating might slip. Treasury Secretary Tim Geithner had to assure everyone that America wouldn't lose the valuable rating, which keeps our borrowing costs low. But even he can't be so sure.