Goldman's Secret Greek Loan

Posted by Mike Tirone - Thursday, March 8th, 2012

Rome wasn't built in one day.

The old adage rings just as true for destruction as well. The Greek financial debt and near collapse of its economic system did not take a day to happen. Actions have been taking place decades in advance laid the groundwork for the Greek system that is now in disarray.

On the other hand, one prominent act, the secret loan which Greece had struck with Goldman Sachs Group Inc. (GS) in 2001, had financial repercussions literally happening overnight.

Over a decade ago, Goldman Sachs agreed to a loan with Greece which would allow the already in debt nation to borrow 2.8 billion euros to allow for Greece to join the eurozone, disguising the European Union of it's astronomical debt.

The transaction was a Grecian mistake of the highest order because the Greek government immediately owed Goldman Sachs 600 million euros ($793 million) more than the original 2.8 billion borrowed, according to Spyros Papanicolaou, Greece's managing director of Public Debt Management Agency. By the time he took office in 2005, the price of the transaction between Goldman and Greece, a derivative that disguised the loan which Goldman Sachs persuaded Greece not to test it out with competitors, had almost doubled to 5.1 billion euros.

Bloomberg reports that Papanicolaou and his predecessor, Christoforos Sardelis, are revealing details for the first time of a contract that helped Greece cover up its insurmountable debt to meet the EU's requirements. And Sardelis is claiming that the government did not understand what it was buying and was ill-equipped to judge the necessary risks or costs of the transaction.

Sardelis oversaw the transaction as head of Greece's Public Debt Management Agency from 1999 through 2004 and he says “The Goldman Sachs deal is a very sexy story between two sinners.”

The problems just seem to stack up with this news coming out. One of the main authority figures in 2001, Sardelis, not only executed the swap from Goldman to Greece but now finds it necessary to announce that the Greek government was not prepared for the secret loan but will not be blamed for the financial collapse in his country.

Goldman Sachs’s instant gain on the transaction illustrates the dangers to clients who engage in complex, tailored trades that lack comparable market prices and whose fees aren’t disclosed. Harvard University, Alabama’s Jefferson County and the German city of Pforzheim all have found themselves on the losing end of the one-of-a-kind private deals typically pitched to them by securities firms as means to improve their finances.

“Like the municipalities, Greece is just another example of a poorly governed client that got taken apart,” Satyajit Das, a risk consultant and author of “Extreme Money: Masters of the Universe and the Cult of Risk,” said in a phone interview. “These trades are structured not to be unwound, and Goldman is ruthless about ensuring that its interests aren’t compromised -- it’s part of the DNA of that organization.”

Goldman Sachs reported $6.35 billion in revenue for trading and principal investments in 2001. The 600 million euros gain from the company's loan with Greece represented 12 percent of those total revenues.

The transaction on Goldnman Sachs' part was one of quite particular maneuvering and scheming. It swapped debt by Greece in dollars and yen for euros using an historical exchange rate, a mechanism that implied a reduction in debt. Bloomberg explains that, “it also used an off-market interest-rate swap to repay loans. Those swaps allow counterparties to exchange two forms of interest payment, such as fixed or floating rates, referenced to a notional amount of debt.”

“Greece actually executed the swap transactions to reduce its debt-to-gross-domestic-product ratio because all member states were required by the Maastricht Treaty to show an improvement in their public finances,” said Fiona Laffan, a spokeswoman for Goldman Sachs in London. “The swaps were one of several techniques that many European governments used to meet the terms of the treaty.” Laffan continued to say that all agreements were executed in accordance with guidelines provided by Eurostat, the EU's statistical agency.

Analysts and advisers are more bold and to-the-point on the transaction, like Saul Haydon Rowe, stating, “it looks like an extremely profitable transaction for Goldman.”

Greece (which is sitting on debt equal to around 160% of its entire GDP as of last year) and it's second bailout of 130 billion euros from last month.