The eurozone: Athenian arrangers
By Kerin Hope, Megan Murphy and Gillian Tett
Published: February 16 2010 19:59
A few weeks ago, a distinctive delegation was spotted in the financial quarter of Athens: bankers from Goldman Sachs were escorting a high-powered team from the investment group run by John Paulson, the American hedge fund guru, around meetings with Greek officials and analysts.
EDITOR’S CHOICE
Greece given month to sway doubters - Feb-16
In depth: Greece debt crisis - Feb-16
Editorial: Brussels and Greek trick - Feb-16
Martin Wolf: How to walk the fiscal tightrope - Feb-16
Opinion: Greek ‘holiday’ from the eurozone - Feb-16
ECB begins leadership overhaul - Feb-16
Investment banks such as Goldman frequently accompany asset management clients on fact-finding trips – and hedge funds such as the Paulson group, which has made huge profits betting on troubled assets in the past two years, are considered an important catch. But in the febrile climate that currently surrounds Athens, the meetings generated wild rumours in several European capitals.
“A lot of people are wondering what they were doing there – the timing, perception of this was unfortunate,” says the chairman of a large European bank.
As the crisis around Greece’s public finances has deepened in recent weeks, Greek and other European officials have been expressing growing unease – if not outright anger – about the role played by western investment banks and hedge funds.
That is partly because of the manner in which hedge funds and others are perceived to be betting against the euro in general, and the debt of economically “peripheral” countries such as Greece in particular, by using derivative instruments such as credit default swaps. But it also stems from the role that Wall Street titans such as Goldman have played in helping Greece and other eurozone countries to massage their debt data over the past decade to meet European limits – and thus to mask some of the fiscal woes that have now come back to haunt international markets.
BANK ACCOUNTING
From Belgian tax to funds put aside in Puglia all on borrowed time
Greece is hardly alone in having managed to flatter its national accounts by employing the services of big investment banks. Numerous other state entities across Europe have engaged in derivatives deals with similar intentions – and sometimes using the most exotic of revenue streams, writes Gillian Tett.
In Italy, regional authorities including Liguria and Puglia have put their so-called “sinking funds” to creative use. With the help of banks such as Nomura or UBS, they have invested these pools of money – into which they are required by law to set aside funds to pay off bonds – in credit derivatives or other assets in recent years. By using the entire future putative value of their sinking fund, they could flatter their books by bringing forward expected future gains.
But perhaps the biggest arena for such accounting-driven transactions lies in securitisation – using the revenues from state assets to back bonds that are sold to new investors. This allows governments to enjoy the benefits of future cash flows up-front while deferring until later the recognition of liabilities.
If the bonds are “ring-fenced” from the state budget – meaning bond investors have direct recourse to the assets and cash flow – these deals were often considered to be partly off-balance sheet. Activity has dropped, though, since Eurostat, the European statistical office, tightened its rules in 2002 and again in 2005.
Italy has been one of the most enthusiastic securitisers of state property. It has also sought on occasion to securitise social security receipts, medical payments and even lottery tickets – using banks including UBS and the former Lehman Brothers.
The approach has not been confined to Mediterranean countries. Belgium has even made an effort to securitise the process of tax collection. In this structure, bonds are issued backed by the future collection of unpaid taxes, which means investors bet on whether the tax inspectors do their job.
Many bankers insist these deals have tangible value that extends well beyond any accounting games. After all, they point out, the investors who buy these securitised bonds, and the agencies that rate them, have a motive to impose real scrutiny on the performance of the underlying assets or programmes. When it comes to the performance of Belgian tax teams, say, investor scrutiny might provide better oversight than anything bureaucrats could achieve.
The one thing that is apparent, however, is that many European countries have been living on borrowed time, in the sense of recording cash flows up-front – but sometimes hoping that future liabilities magically disappear.
It is a tale that in some respects echoes the furore surrounding the subprime mortgage crisis in the US in 2007 – where big investment banks were blamed for ramping up systemic financial risk by packaging and selling on high-risk mortgage loans to investors.
Tensions surrounding the 11-year-old single currency zone, which Greece joined in 2001 and now embraces 16 countries, have never been more intense as one of its founding assumptions – that government bonds issued by member states are of equal standing – is put to the test by the markets.
Goldman burst on to the Athens scene in 2002 by arranging a massive swaps transaction aimed at reducing the cost of financing that country’s public debt, which had reached a level that exceeded annual gross domestic product. The deal involved some €5bn ($6.8bn, £4.4bn) of off-market cross-currency swaps linked to outstanding Greek debt, where bonds denominated in yen and dollars were swapped for euros.
Because it was treated as a currency trade rather than a loan, it helped Greece to meet European Union deficit limits while pushing repayments far into the future.
Bankers and officials say the swaps were legal, that they were in line with EU accounting rules that prevailed at the time, and that similar transactions had already been arranged between investment banks and other southern eurozone countries including Italy and Portugal. The nature of the Goldman deal was, however, that it remained out of public view and did not show up on Greece’s balance sheet until the following year, when the country’s debt-to-GDP ratio fell from 105.3 per cent to 103.7 per cent.
The deal was put together by Antigone Loudiadis, herself of Greek origin, who was Goldman’s head of sales at the time for its European fixed-income and currencies unit. Goldman is said to have taken about €1bn of credit risk, which it hedged with a German bank, while Greece’s debt management agency paid an unprecedented €200m in fees and charges. Goldman transferred the swap in 2005 to National Bank of Greece, the country’s biggest commercial lender. NBG set up a special-purpose vehicle called Titlos and transformed the swap into a 20-year securitisation bond, which stayed on its books – thus giving the government a further breathing space.
In spite of the high transaction costs, the 2002 deal established Goldman’s reputation in Greece as a “can-do” investment house. “It was a large, lucrative deal that made other investment banks green with envy,” says a Greek banker.
Goldman still keeps a relatively low profile in Greece. Unlike other investment banks, it has not set up an Athens representative office, though it draws on the local knowledge of staff based elsewhere in the group, such as Ms Loudiadis. But since the Panhellenic Socialist Movement of George Papandreou, Greece’s prime minister, came to power last October, Goldman has become better known.
Gary Cohn, its chief operating officer, has met Mr Papandreou twice in Athens in the past three months. Goldman, along with Deutsche Bank, also took George Papaconstantinou, the finance minister, on his first investment roadshow last November when he visited London and Frankfurt. The US bank is expected to help organise others to the US and Asia as Greece tries to widen its investor base for bond purchases. “Goldman is in pole position to advise Greece on raising funds in this time of crisis,” says one former finance minister.
That is in spite of the bank’s involvement in the controversial currency swap of eight years ago, about which Eurostat, the EU’s statistical agency, this week said it was seeking further information. The deal was carried out just ahead of a tightening of Eurostat’s rules on how countries should account for public debt. Nikos Christodoulakis, another former finance minister – who was in charge in 2002 – told the Financial Times yesterday: “Regarding the swap with Goldman Sachs, it was recorded according to Eurostat rules.”
Goldman declined to comment on Eurostat’s announcement on the Greek currency swaps or on Athens introductions performed for the Paulson group. However, insiders, including former Greek finance ministry officials involved in these deals, express surprise at the assertion that Eurostat had not long been fully informed about the deals, as their detail has been in the public domain for several years.
Since the emergence of the Greek crisis, Brussels has sought to tighten the rules that govern the reporting of member states’ fiscal statistics even further. The new Athens government has meanwhile attempted to clarify what went on under its predecessor. A finance ministry report on the “credibility of public finance figures”, released last month, says in a footnote: “The significant revisions observed in the debt figures at the end of the 1990s and start of the 2000s are due to a significant extent to the use of specific financial products such as securitisations. The statistical recording of these products at that time was unclear.”
Investor unease, however, extends beyond the current turmoil over Greece or antics in the world of sovereign credit default swaps. In recent years, a number of European countries have used complex financial deals such as securitisations or derivatives trades to flatter their accounts, usually by bringing forward the recognition of revenues – or by deferring the recognition of liabilities into the future. And a brace of investment banks have helped to arrange these deals, often for fat fees (see below).
As with the Greek swaps deal, the banks involved in these deals stress that they were all legal. Some also suggest that their frequency has fallen sharply in recent years, not least because of changes in Eurostat requirements.
Still, some officials in Brussels are left irritated. “Some of what has happened really sticks in the craw,” says one senior European Commission official. “You have the sense that banks have been playing all sides of this, making money whatever happens to Greece.”
But the big issue now is whether this simmering anger could turn into a more serious backlash if market pressures build.
Unsurprisingly, most senior bankers – and hedge funds officials – argue that it is entirely unfair to blame them for the current woes. Most notably, they argue, if countries such as Greece are in trouble today, that is largely because they have mismanaged their finances over many years, running up vast debts as budget deficits have grown amid a steady decline in competitiveness.
If the euro is under pressure now, they add, that reflects the lack of a fiscal agreement or political infrastructure to manage the currency union, rather than speculative attacks by hedge funds.
“It is ridiculous to blame hedge funds – that is really a case of shooting the messenger,” says one senior Wall Street hedge fund official. Or as Johannes Jooste, portfolio manager at Merrill Lynch Wealth Management, puts it: “The reason why the Greek bond markets sold off and credit default swaps rose to records was because of the poor state of the country’s public finances. Hedge funds sold or shorted Greek bonds because of the economics, not because they have some agenda against Greece.”
Nevertheless, if the crisis builds, there are two issues that could provoke more finger-pointing. The first is the murky nature of the markets in which investors are placing their bets. Sovereign credit default swaps, for example, are conducted away from any exchange, which makes it impossible to track volumes of trading in a timely manner or even tell exactly who the main buyers and sellers might be.
As a result, there is widespread unease, both inside and outside the financial world, that canny investors can sometimes drive prices by spreading rumours or employing heavy-handed trading tactics to make quick profits.
The second concern is that some of the investment banking, derivatives and securitisation deals struck in the eurozone countries in recent years have been arranged in slightly occluded circumstances of their own.
“At some banks, things have sometimes gone on at a local level that head office might not really understand,” admits the European head of one American investment bank. “Skeletons could tumble out.”