How a secret Goldman loan ended up fleecing Greece

Bloomberg ran an interesting article on how Goldman used a secret loan to help Greece meet the requirements for joining the EU.

By itself, this secret loan makes the case for requiring financial institutions to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

• Would this secret loan have taken place if the next day Goldman would have had to report this exposure?

• Would Greece have been allowed into the EU after financial regulators saw this transaction and brought the EU policy makers' attention to it?

The article also discussed the cost of this secret loan.  A cost that was significantly higher due to the fact that the loan was suppose to be kept secret.

Greece’s secret loan from Goldman Sachs Group Inc. (GS) was a costly mistake from the start. 

On the day the 2001 deal was struck, the government owed the bank about 600 million euros ($793 million) more than the 2.8 billion euros it borrowed, said Spyros Papanicolaou, who took over the country’s debt-management agency in 2005. 

By then, the price of the transaction, a derivative that disguised the loan and that Goldman Sachs persuaded Greece not to test with competitors, had almost doubled to 5.1 billion euros, he said.

Papanicolaou and his predecessor, Christoforos Sardelis, revealing details for the first time of a contract that helped Greece mask its growing sovereign debt to meet European Union requirements, said the country didn’t understand what it was buying and was ill-equipped to judge the risks or costs. 

“The Goldman Sachs deal is a very sexy story between two sinners,” Sardelis, who oversaw the swap as head of Greece’s Public Debt Management Agency from 1999 through 2004, said in an interview. 

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.”.... 

“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,” Laffan said in an e- mail. “The swaps were one of several techniques that many European governments used to meet the terms of the treaty.”... 

Under Eurostat accounting rules, nations were permitted until 2008 to use so-called off-market rates in swaps to manage their debt. Greek officials, including Sardelis, say they learned that other EU countries such as Italy had employed similar methods to shrink their debts, taking advantage of the secrecy of over-the-counter derivatives compared with swaps traded on exchanges....

Greece was handicapped, in part, by the terms Goldman Sachs imposed, he said.
“Sardelis couldn’t actually do what every debt manager should do when offered something, which is go to the market to check the price,” said Papanicolaou, who retired in 2010. “He didn’t do that because he was told by Goldman that if he did that, the deal is off.”... 

Gustavo Piga, a professor of economics at University of Rome Tor Vergata and author of “Derivatives and Public Debt Management,” sees a different lesson. 

“In secret deals, intermediaries have the upper hand and use it to squeeze taxpayers,” Piga said in an interview. “The bargaining power is in investment banks’ hands.”