The Trojan Horse Meets the Vampire Squid
The Greek debt dodge invites the question: Who will regulate the regulators?


Kevin D. Williamson

You want to see something that makes a trailer-load of dodgy mortgage derivatives look like an old-fashioned savings bond? Look at the Greek government’s crafty technique for borrowing money without having to put any new debt on the books. It’s a fascinating financial instrument dreamed up by our old buddies at Goldman Sachs — and the debt goes right back to Greek banks.

A little background: Governments in the European Union cannot just go borrowing money willy-nilly, at least in theory. Under the terms of the Maastricht treaty, which established the European Union and led to the creation of the euro, EU states are supposed to keep their government deficits below 3 percent of GDP, and total government debt is not to exceed 60 percent of GDP. Greece has never been particularly good about meeting its Maastricht obligations, but even the Mssrs. Magoo in Brussels could not ignore Athens’s profligate ways forever. So the Greeks needed a way to borrow some money without having to issue bonds or engage in other conventional debt-financing measures that would put the debt on the national books.

So they called Goldman Sachs, the bank that seems dead-set on living up to Rolling Stone’s description of it as a “giant vampire squid wrapped around the face of humanity.” Goldman Sachs loves to help distressed governments borrow money — and then get the risk onto somebody else’s books as quickly as possible. Example: After helping the all-but-formally-bankrupt state government in California borrow a heap of money through issuing new bonds and collecting a multimillion-dollar fee, Goldman recommended to its clients that they be wary of the bonds — which was likely good advice, as Sacramento’s finances are a mess.

But governments don’t just put bonds on the market; they engage in all kinds of complicated financial transactions, often for very good reasons. One of the things governments sometimes do is called a currency swap, which is basically a bet on the fluctuations of their own currency and those of foreign countries. Currency swaps can be useful, because they help governments hedge the risk of sudden changes in foreign-exchange rates. When the Greeks came looking for some spare change, Goldman created a special kind of foreign-exchange swap, called a cross-currency swap, that essentially allowed the Greek government to borrow money without being seen to do so.

As the Spiegel reports, Goldman simply made up exchange rates, which allowed the Greeks to swap an amount of one currency for a different amount of another currency — taking about $1 billion out of the transaction. This money will have to be paid back, but it did not show up on the books as sovereign debt. There’s nothing illegal about that, but there’s plenty that’s sneaky. The European authorities do not keep a very close eye on financial derivatives of this sort, so this Trojan Horse financing didn’t show up for some time.

Greece isn’t alone in doing this: Italy apparently has been doing this for years. Felix Salmon reports that Goldman helped create something with the deliciously Wagnerian name of Aries Vermoegensverwaltungs to help Germany hide some sovereign debt. And the guys at Goldman Sachs are no fools: They sold those Greek swaps to a Greek bank back in 2005.

The European Union today will convene an emergency meeting to stave off the possibility that Greece will default on its sovereign debt. Something on the order of a national bailout is probably in the works, and Greece may not be the end of it: Portugal, Italy, Ireland, and Spain — collectively known, with Greece, as the PIIGS — all are in critical condition. And it’s not just their public finances: The financial bubble was not only an American phenomenon (arguably, it was not even principally an American phenomenon), and Europe’s banks went way out on a financial limb, getting themselves fatly leveraged up and making enormous loans in the now-fragile boomtown economies of Eastern Europe. Many of those banks have exposures to Eastern Europe — alone — that exceed their countries’ GDPs.