Goldman Sachs may have helped fool Greek bond buyers

By Elisa Martinuzzi
Bloomberg News
Wednesday, February 17, 2010

http://www.bloomberg.com/apps/news?pid=20601087&sid=asBNXSLtlN9E&pos=1

Goldman Sachs Group Inc. managed $15 billion of bond sales for Greece after arranging a currency swap that allowed the government to hide the extent of its deficit.

No mention was made of the swap in sales documents for the securities in at least six of the 10 sales the bank arranged for Greece since the transaction, according to a review of the prospectuses by Bloomberg. The New York-based firm helped Greece raise $1 billion of off-balance-sheet funding in 2002 through the swap, which European Union regulators said they knew nothing about until recent days.

Failing to disclose the swap may have allowed Goldman, a co-lead manager on many of the sales, other underwriters, and Greece to get a better price for the securities, said Bill Blain, co-head of fixed income at Matrix Corporate Capital LLP, a London-based broker and fund manager.

"The price of bonds should reflect the reality of Greece's finances," Blain said. "If a bank was selling them to investors on the basis of publicly available information, and they were aware that information was incorrect, then investors have been fooled."

Michael DuVally, a spokesman at Goldman Sachs in New York, declined to comment.

Goldman Sachs, Wall Street's most profitable securities firm, is being criticized by European politicians, including Germany's ruling Christian Democrats, who have questioned whether the firm helped Greece hide its deficit to comply with the currency's membership criteria. Greece is also being faulted by fellow euro-region countries for failing to disclose the swaps to EU regulators.

The swaps used by Greece to manage debt were "at the time legal," Greek Finance Minister George Papaconstantinou said on Feb. 15. The government doesn't use the swaps now, he said.

Eurostat, the EU's statistics office, this week ordered Greece to hand over information on the swaps transactions by the end of this week in an investigation that may extend to other EU countries.

Goldman Sachs earned about 735 million euros ($1 billion) underwriting Greek government bonds since 2002, data compiled by Bloomberg show. Goldman Sachs underwrote 10 bond sales. Prospectuses for six of them, obtained by Bloomberg, contain no mention of the swaps. The other four couldn't be obtained.

The yield on Greek 10-year government bonds jumped to as much as 7.2 percent on Jan. 28 amid the worst crisis in the euro's 11-year history. The premium, or spread, investors demand to hold Greek 10-year notes instead of German bunds, Europe's benchmark government securities, widened yesterday by 18 basis points to 323 basis points.

The spread reached 396 basis points last month, the most since the year before the euro’s debut in 1999, compared with an average of 57 basis points in the past decade. A basis point is 0.01 percentage point.

"When people start to fear that the numbers aren't accurate, they fear the worst," said Simon Johnson, a former International Monetary Fund chief economist who is now a professor at the Massachusetts Institute of Technology's Sloan School of Management in Cambridge, Massachusetts.

Goldman could face legal liability "if it could be established that they were knowingly hiding risk, and therefore knew or had reason to know that the bond disclosure documents were misleading," said Thomas Hazen, a law professor at the University of North Carolina at Chapel Hill. "But that would be a tough hill to climb, in terms of burden of proof. There'd have to be some sort of smoking-gun memo."

The swap enabled Greece to improve its budget and deficit and meet a target needed to remain within the region’s single currency. Knowledge of their existence may have changed investors' perception of the risk associated with Greece, and the price they may have been willing to pay for the country's securities.

"From what we know, this is an egregious example of a conflict of interest" for Goldman Sachs, MIT's Johnson said. "Even if the deal had been authorized, it doesn't let them off the hook."

A Greek government inquiry this month identified a series of swaps agreements with securities firms that allowed the country to hide its mounting deficit. Greece used the swaps to defer interest payments, causing "long-term damage" to the Greek state, according to the Feb. 1 document, commissioned by the Finance Ministry.

European Union officials said this week they only recently became aware of the transaction with Goldman. The swaps don't necessarily break EU rules, European Commission spokesman Amadeu Altafaj told reporters in Brussels on Feb. 15.

The transaction with Goldman consisted of a cross-currency swap of about $10 billion of debt issued by Greece in dollars and yen, according to Christoforos Sardelis, head of Greece’s Public Debt Management Agency at the time.

That was swapped into euros using a historical exchange rate, a mechanism that implied a reduction in debt and generated about $1 billion in an up-front payment from Goldman to Greece, Sardelis said. He declined to give specifics on how the swap affected the country's deficit or debt.

European politicians such as Luxembourg Treasury Minister Jean-Claude Juncker this week criticized Goldman Sachs for arranging the Greek swap and are pressing the firm and Greece for more disclosure. Chancellor Angela Merkel’s Christian Democrats aim to push for new rules that will force euro-region nations and banks to disclose bond swaps that have an impact on public finances, financial affairs spokesman Michael Meister said.

"Investment banks are guilty of being part of a wider collusion that fudged the numbers to make the euro look like a working currency union," said Matrix's Blain. "The bottom line is foreign exchange and bond investors bought something sellers knew not to be the case."

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