The Greek derivatives aren’t Goldman’s fault

By Felix Salmon
February 16, 2010
the definitive account was published by Nick Dunbar of Risk magazine in July 2003. He kicked off by saying that the deals he was writing about "are likely to prove controversial" -- he probably never guessed just how controversial they would end up being, nor how long it would take them to achieve that status.

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The first thing you have to know about the Greece-Goldman story is that the definitive account was published by Nick Dunbar of Risk magazine in July 2003. He kicked off by saying that the deals he was writing about “are likely to prove controversial” — he probably never guessed just how controversial they would end up being, nor how long it would take them to achieve that status.

The details of the deal are more or less what I suspected, and indeed the Spiegel story hews so closely to Dunbar’s account that the Risk article was clearly a primary — if not the primary — source. Here’s Dunbar, explaining what went on:

The cross-currency swaps transacted by Goldman for Greece’s public debt division were ‘off-market’ – the spot exchange rate was not used for re-denominating the notional of the foreign currency debt. Instead, a weaker level of euro versus dollar or yen was used in the contracts, resulting in a mismatch between the domestic and foreign currency swap notionals. The effect of this was to create an upfront payment by Goldman to Greece at inception, and an increased stream of interest payments to Greece during the lifetime of the swap. Goldman would recoup these non-standard cashflows at maturity, receiving a large ‘balloon’ cash payment from Greece…

It seems the total credit risk incurred by Goldman Sachs was roughly $1 billion. Effectively, Goldman Sachs was extending a long-dated illiquid loan to its client.

Dunbar also goes into a lot more detail about the fees on the transaction than the NYT does. I think it’s reasonable to accuse the NYT of being unfair to Goldman when it writes that Greece “paid the bank about $300 million in fees for arranging the 2001 transaction”. The point here is that because this is a cross-currency swap rather than a bond deal, the interest payments are going the wrong way: Goldman is sending Greece a steady stream of payments over the course of the deal, and then being repaid with a big balloon payment at the end. Essentially, Goldman is continually lending Greece money, and getting no interest payments in return, until maturity a long way out.

So the fee associated with the deal isn’t a fee for arranging the transaction, as the NYT would have it: instead, it has to cover all of the credit and market risk that Goldman Sachs is taking on in lending the money to Greece. What’s more, a very large chunk of the fee was immediately paid to Depfa, which sold Goldman a $1 billion 20-year credit default swap on Greece to hedge its credit risk. And for what it’s worth, Dunbar’s article puts Goldman’s total charge for the transaction at $200 million, not $300 million: I have no idea which figure is more reliable.

It’s also a bit disingenuous of the EU to start saying now that Eurostat was not aware of the transaction. Put aside for one minute the fact that Eurocrats have been known to read Risk; Dunbar’s article actually goes into some detail about how the Eurocrats knew exactly what was going on:

The drafting of ESA95’s section on derivatives was the subject of fierce arguments between the government statisticians and debt managers of certain eurozone countries.

The statisticians wanted derivatives-related cashflows to be treated as financial transactions, with no effect on deficit or interest costs, and with the derivatives’ current market value stated as an asset or liability. The debt managers opposed this, insisting on having the freedom to use derivatives to adjust deficit ratios. The published version of ESA95 reflects the victory of the debt managers in this argument with a series of last-minute amendments.

In particular, ESA95 states in a page-long ‘clarification’ that ‘streams of interest payments under swaps agreements will continue… having an impact on general government net borrowing/net lending’. In other words, upfront swap payments – which Eurostat classifies as interest – can reduce debt, without the corresponding negative market value of the swap increasing it.

In other words, Eurostat knew that Greece, Italy, and others were planning this kind of deal even before they happened, thanks to their successful lobbying efforts with respect to ESA95, and it was inevitable that they would structure deals with investment banks doing exactly what they did.

So while it’s entirely fair to blame Greece for trying to hide its debt, and to blame Eurostat for letting it do so, I think that blaming Goldman is harder. It was surely not the only bank involved in these transactions, and the swaps were simple enough to be shopped around a few different banks to see which one could provide the best deal. Structuring swaps transactions is one of those things which investment banks do. If countries like Greece buy swaps in order to hide their true fiscal status, then that’s the country’s fault, not the banks’. No self-respecting bank would decline such a transaction because they felt it was unfair to Eurostat.

Yes, I’m sure that Goldman put a team of people onto the Eurostat rules and made that team available to the Greeks. But let’s not blame the advisers here, for structuring something entirely legal and which the Greeks and Italians clearly wanted to be able to do all along. This is a failure of European transparency and coordination; Goldman is a scapegoat.


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Arms dealers don’t kill people. People who buy weapons from arms dealers kill people. With weapons they bought from arms dealers.

Then again, if there were no arms dealers, people would still be killing each other with rocks. You pays your money, and you takes your choice …

Posted by EpicureanDeal | Report as abusive

A bit like saying let’s blame the addict, not the pusher.

The problem with your analysis, Felix, is that Goldman has been down this road before, with Russia in the 90s: ss/easy-money-special-report-for-russia- its-us-bankers-match-wasn-t-made-heaven. html?pagewanted=all

And that debacle helped trigger the LTCM collapse, which nearly brought down the global finanace system then, too.

So yes, it was legal, and yes of course the Greeks are primarily to blame. But having been through this before, Goldman should have known the likely consequences of its actions, and should now be held accountable for them.

Posted by MaggiesFarmboy | Report as abusive

Are profit and mere legality the only measure of propriety? What about common sense? Common decency? Is there no shame?

Posted by JamesRickards | Report as abusive

Them employees of Goldman who are CFAs and members of the CFA Institute are bound by a Code of Ethics that (in part) prohibits market manipulation: Standard II. B. “Members must not engage in practices that distort prices … with the intent to mislead market participants.” s/ethics/pdf/english_code.pdf

Just because it is legal does not make it ethical. Someone at Goldman or any other bank should have said “this — especially an off-market transaction — is misleading.”

Failure to do so is arguably subject to sanction by the CFA Institute. While not a civil or criminal penalty, it at least can be said to be career-limiting.

Posted by Publius | Report as abusive

“Structuring swaps transactions is one of those things which investment banks do.” This is the key to Felix’s defense of Goldman. As the other commenters have rightly pointed out, it is no defense at all. The question is: why should structuring swaps transactions that hide sovereign debt be something that investment banks do? If we think it should not be something that they do, they we must censure the practice.

Posted by Wismar | Report as abusive

what you are saying is it was legal to help Greece have more debt than recorded by those who track Euro area public debt. This could be true. However if GS was involved in any sales of Euro area debt or related instruments to 3rd parties would it not have had some duty of disclosure that it knew that the debt burden figures of of Greece and others were not accurate? is this not a liability?

Posted by micromeme | Report as abusive

The thing that none of the commenters are dealing with is that the EU specifically allowed this practice. If this were a fraud, the victims would be the EU member states, who gave Greece all the benefits of membership when it did not, in fact, qualify for them.

It isn’t merely legal in the sense that Goldman found some loophole that no one expected and exploited – it is explicitly authorized, apparently because a lot of countries wanted the option to do precisely the same thing Greece did.

The only way I can see this being indecent is if Greece exploited this to a level that no one anticipated.

Its like we’re playing a game of tackle football, and when the first kid gets hurt, we criticize the guy who tackled him for not playing touch. The only way we’ve got a legitimate beef is if the tackler was playing much rougher than everyone else – kicking and biting and body slamming and whatever.

I’m not sure what Russia has to do with this. That wasn’t an issue of fraud – that was an issue of Russians and bondholders misguessing how much Russia could raise in taxes. These are big boys and girls, its not Goldman’s job to police them.

Posted by AnonymousChef | Report as abusive

First of all, aren’t you glad that Risk article didn’t vanish behind a paywall? Goldman is too, I bet. Maybe it’s not to late for them to tweet about it. But I think it is.

Second of all, how about them WMDs? Who can truly say they never existed and still lap up all the war pork gravy with a silver spoon? In 21st Century Greek logic, that would be the most polite analogy here.

Who besides present company could blame others for drawing comparisons with the Slave Trade, or statutory rape, with Goldman as Polanski having Sachs with a minor and Eurostat as the kid’s mother. It’s just “what investment bankers do” – right?

Third of all, $200M in 2003 will get you $300M at maturity point on a 20-year long con. Others might very well argue, 30 years’ hard labor for financial crimes against nature would be more appropriate.

Nomatter which way you look at the scenario, it definitely answers the Big W Conundrum, namely, “Whah dew they hayte uh-ass?” Cuz it’s what they’re gonna do, for generations.

Posted by HBC | Report as abusive

Dear AnonymousChef

I’m not suggesting that Goldman should be policing anybody. I’m suggesting that Goldman needs to be policed.

Posted by MaggiesFarmboy | Report as abusive

I’d agree that Goldman is being made a scapegoat here. Governments across Europe were doing deals, arranged by all sorts of banks, worth tens of billions of euros that were ESA 95 compliant to be off balance sheet (at the time of issue) but clearly direct liabilities of the government. Italy alone had over Eu12bn of them. Many of these were brought back on balance sheet in 2002 and again in 2005 when Eurostat tightened its rules. By all means criticise the banks for arranging them and the countries for trying to get around the PSBR limits, but focusing on Goldman is missing the wood for the trees.

Posted by GingerYellow | Report as abusive

Dear MaggiesFarmboy,

What, exactly, did Goldman do wrong in Russia? The Russians wanted loans, investors wanted to invest in Russia, Goldman simply hooked them up. It ended up in disaster because of failures by Russia and the investors to make sure that Russia’s debt obligations are manageable.

Posted by AnonymousChef | Report as abusive

Depfa, the seller of the CDS to Goldman, is a division of Hypo Real Estate (HRE). HRE was nationalized by Germany (10/08) only a year after HRE bought Depfa (10/07). Another reason why Germany is interested in Greece’s debt.

On the subject of banks buying banks only to end up being nationalized…

While not the same it reminds me of Creditanstalt (Austria-Hungry) circa 1931, when the bank was rescued by Oesterreichische Nationalbank and the Rothschilds, only to be nationalized later on.

In both instances the problems of the banks up being the problems of the people.

Posted by david3 | Report as abusive

Whether Goldman is an amoral entity providing a service to countries/individuals who are clearly in over their heads, or it is knowingly providing “advice” to these same parties against their long-term interests, is probably debatable. It is noteworthy that Goldman effectively bet against Greece.

But Goldman is also continually facilitating behaviours that it should know will cause a great deal of collateral damage to third parties, if not the entire structure of global finance.

It might be “legal” to do so. But if it is, it is time to change the laws.

Posted by MaggiesFarmboy | Report as abusive

“It might be “legal” to do so. But if it is, it is time to change the laws.”

Who do you think makes the laws? Lawmakers? LOL.

Posted by Miltdog | Report as abusive

Felix –

From Goldman tormenter to defender — what happened?

Goldman’s efforts helped hide important information not only on the EU but also on investing public. Hiding debt in the way that they did might have been legal, but it certainly is not ethical, not by any principle of ethics that I have ever heard of.

Goldman is morally and ethically bankrupt, and you are not being helpful by defending them.

Felix, are you hoping for a nice Goldman job after you give up blogging and settle down and have a family?

For goodness sake, please wipe Lloyd’s juice off your face, it looks undignified.

Posted by DanHess | Report as abusive

According to Bloomberg
( 20601087&sid=aZom2jvtHvWk&pos=1)

Finance Minister George Papaconstantinou said yesterday the use of swaps was “at the time legal.” The contracts are now no longer legal, and Greece doesn’t use them

For those (Goldman Sachs, Felix Salmon) whose notions of ethics apparently extend no further than the limits of the law, does it mean anything that Europe saw fit to outlaw the Goldman/Greek derivatives?

Is it not surprising that Goldman’s president continued to try to entice Greece to hide its debts as recently as November? In November, the Greek government emerged as the clearly more ethical party.

Posted by DanHess | Report as abusive

The problem is that Goldman Sachs is the smartest company around until they get caught doing what unregulated bankers do every time, stealing our money with the help of corrupt politicians and then they stand there looking persecuted and picked on.

The author most revealing statement on just how low the ethics of International Banking has sunk, when he syas,

“No self-respecting bank would decline such a transaction because they felt it was unfair to Eurostat.”

You can be sure that if the banks aren’t self-respecting they won’t get any respect at all, what the public is looking for is justice for the recent thefts and a long term regulation that will put banks back in the business of loaning to businesses instead of buying them, leveraging them, paying themselves huge bonuses, IPO’ing them and paying themselves big bonuses and then going into Chapter 11 with no penalties, just more fees.

But Congress passes a law that doesn’t allow students to default on loans, but let’s financial firms walk away from smoldering ruins with profits.

They are indefensible.

Goldman Sachs paid an effective tax rate of .5% on Billions of earning

Posted by jstaf | Report as abusive

I recall July/August 1998. Some 300 of us were crowded into the Metropole in Moscow waiting to hear the word from Lipton. We had followed the Asst Tsy Secy who was dispatched by Summers to query the Russians on what happened to the $4b that was sent to their central bank just a month prior. Apparently it disappeared from the FRBNY just as soon as the Russian Central Bank was credited. Unable to meet with Dubynin et al, and only given an audience with the PM who expressed total ignorance, Lipton signalled “machst nicht” to Summers and Clinton pulled the plug. At the same time GS was busy scouring for takers of its 10b new issue of Russian bonds. The bids fell woefully short just 6.5b. GS spun around and went short. Short positioning (they said at the time)in order to offer their customers bids for the inevitable deluge of sellers… That’s Goldman.. even in Corporate bonds they oversell 15%, delaying deliveries to little people like us, whilst satisfying customers like Pimco.. then picking up in the secondary markets as the bonds fall in price, to deliver to us, often 3 weeks late..

Posted by Bludde | Report as abusive

Don’t Know Who Sucks More? Felix or Goldman???

Posted by KirkD | Report as abusive

Yet another case of derivatives being structured for regulatory arbitrage (not capital relief for a change, but what sounds suspiciously like the sovereign equivalent thereof). Remind me again what legitimate purpose derivatives serve; I’m quickly losing faith.

Posted by Sandrew | Report as abusive

Criticizing a risk deal ex post is like calling the flip after looking. When debtors breach, the lenders were “immoral thieves”? We heard the same in US sub-prime (ca 2007). What about those who didn’t hold their end of the bargain? Why is Greece martyred for poorly managing GS’ investors’ assets?

Maybe all the Monday morning QBs can don their holy sandals and smooth revenue/expenses through time without risk capital… or with their OWN capital.

Did GS breach contract? This is GS’ problem (they lent the money), but how their fault?

If banks “don’t lend” or they lend “too much”, the same people complain. Where’s their bank?

Posted by expost | Report as abusive

Just because a deal is made, doesn’t mean that it cannot be declared a fraud, and its course reversed. Think – “lemon law” in car buying. So I think it is perfectly reasonable to criticize a deal even after it is done if it becomes evident that information was purposefully consealed.

Posted by comment | Report as abusive

It will indeed be interesting to see if the CFA says anything. I very much doubt it. Cheers

Posted by yankeee | Report as abusive

It´s good to be Goldman Sachs!

Posted by yankeee | Report as abusive

They are a Cabal of smart people all “doing Gods work”

Mr.Salmon probably feels it is just “doing business”

Never mind the peasant and working class gets burned.

They know we can do nothing about it.

Posted by breckandy | Report as abusive

@expost –

Either you don’t understand or are purposefully trying to confusing the issue. The problem is not that Goldman is lending. The problem is that they lent to a country in a way that was structured expressly to deceive Europe and the public. Their product was not the loan. Greece had access to the bond market. Rather they were selling financial deception. It is financial deception that was not available on the simple bond market.

As for Greece, they are definitely getting their share of scorn over this.

Posted by DanHess | Report as abusive

I wonder if the poor taxpayers of Greece understand that the German government is attempting to avoid liability on the CDS that Depfa sold to GS.

Posted by rootless_e | Report as abusive

DanHess : Absolutely not. The loan was structured to use a method for pretending loans away that was specifically authorized by the same EU regulators who are now pretending to be shocked. Certainly the German government, after dumping 35BEuros into Hypobank is not a stranger to the subject of financial chicanery on this scale.

Posted by rootless_e | Report as abusive

following up on the earlier comment –
(see bloomberg 0601087&sid=asBNXSLtlN9E )

“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.”

Hat tip John Cole (ie the-masters-of-the-universe-strike-again  / )

Posted by micromeme | Report as abusive

Why are we so mad at Goldman as compared with the others? Aren’t all of these banks engaged in the same questionable things?

Goldman is supposed to be America’s best. They are a role model that all of Wall Street aims (for better and usually for worse) to emulate. If Goldman Sachs does something, it is fair game for everybody.

We expect Goldman Sachs to be one of America’s crown jewels. That is why Goldman’s poor ethics bothers us so much (even beyond the economic harm, which is great). If it was some second rate investment house that was doing these ethically abhorent things, we would be much less troubled.

Posted by DanHess | Report as abusive

At the center of these derivatives were currency swaps that used false and dishonest numbers for exchange rates. Goldman’s term ‘historical exchange rates’ is hilarious. My ‘historical weight’ is a svelte 145 lbs, but if I go around telling people that I will recieve laughter.

Posted by DanHess | Report as abusive

I agree with you and contend that:
The Greek government requested explicitly this kind of deal to meet the criteria to get into the Euro;
The European Commission (its officials and desk officers) which is in charge to monitor member states’ economies knew about it;
Eurostat (its officials and missions team members) which provides data to “certify” the national accounts knew about the deal and did not construed it as a problem of regularity and legality.

Alternatively we have to think that officials in the EU institutions are incompetent (some really are about swap deals at least) and they did not see this coming. However bearing in mind the size of the operation and the numbers the deal cannot go unnoticed (particularly for Bank of Greece and balance of payments accounts).

Moreover some officials dealing with this in the European Commission and Eurostat are and were Greek.

Under the above circumstances one would conclude that Goldman Sachs provided the requested services and of course made money with it.

Posted by M.G.inProgress | Report as abusive

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