Monday, February 22, 2010

The Big Fat Greek Debt Crisis: An Epic Financial Saga?

Even though the country’s sovereign debt problems only started to threaten the stability of the euro in 2010, is the sovereign debt crisis that affected Greece long in the making?


By: Ringo Bones


It can only be described as somewhat shocking news to anyone with a vested interest to the monolithic European super-currency – not to mention countless Greeks with nary a financial safety net – but the sovereign debt crisis affecting Greece which recently became newsworthy seems to have started as far back as 2001. It had been revealed to the mainstream financial news providers in February 19, 2010 that Greece made a currency deal / currency swap with Goldman Sachs back in 2001 in order to cover-up the country’s budget deficit. Though perfectly legal under the EU rules back then, many financial experts had now blamed this move as the root of the big fat Greek sovereign debt crisis that now threatens the value and long-term stability of the euro. With this fiasco, could the role of banks in financial crises such as these put them under scrutiny once again?

The current Greek administration insists that the practice was above board. Even Prime Minister George Papandreou keeps reiterating that Greece needs financial aid – not financial bailout. Given I’m somewhat perplexed of this arcane financial maneuver I started asking the financial experts in our neighborhood. All of them say that the sheer complexity and rigmarole of such over the counter instruments deals – like a typical currency deal / currency swap can be a very effective way of covering up a typical budget deficit problems suffered by a typical country. Of countries and individual persons, it can also be a very effective credit rating booster in the short-term, akin to someone sporting a 2,000 US dollar Armani suit even though they earn less that 25,000 US dollars a year.

As a recently designated member of the PIIGS countries – i.e. the poorest performing economies in Europe as in Portugal, Ireland, Italy, Greece and Spain – Greece has been forced to take extremely draconian actions in order to pay its sovereign debt. Like a proposed pay-freeze on public sector workers that made many Greek government employees threatening to go on a strike. Such unpopular austerity measures will probably only anger your typical working-class Greek who view the “institutionalized corruption” - described by most working class Greeks as the "Octopus" - in some sectors of the government as the root cause of the sovereign debt crisis. Not to mention the unprovoked shooting of a young demonstrator by the Greek police is still fresh on everyone’s minds.

And if this goes on any longer, the longer will Greece improve their sovereign credit rating from near-junk status as the world’s leading credit rating agencies downgraded the country’s credit rating since the crisis came to light. Remember back in 2008 when many highly paid non-American entertainers doing their shows in the US insisted on being paid in euro since the US dollar’s value kept on plunging? Now it’s the almighty euro that’s in trouble.

9 comments:

VaneSSa said...

Despite of its deceptively simple nomenclature, currency swaps are fairly complex financial instruments - almost as complicated as credit derivatives. These could - in a way - raise your credit rating, wile exposing the policyholder to unnecessary risks of the global market. The fat-cats at the investment bank Goldman Sachs should have been more forthcoming about the possible risk involved when they made this deal with Greece back in 2001.

April Rain said...

The last time I researched it, currency swaps are long-maturity over-the-counter derivatives. That is, they are bilateral contracts in which parties agree to exchange long-term streams of interest payments in different currencies. So if I'm a sovereign country or a company, why would I want to enter into one of these currency swap type agreements?

Ringo said...

There are a lot of reasons, April, that a sovereign country or a company would want to enter in a currency swap type agreement. But one of the most common reasons is that if one borrowed money in another currency and one is concerned about foreign exchange rate fluctuations. So for instance if I'm the sovereign nation of Greece and I borrow dollars from the United States, I have to pay that particular debt back in U.S. dollars. But say I'm worried that the U.S. dollar might strengthen against the euro before I can pay in full. That could add a lot to my debt burden. So I might prefer to repay the debt in euros via the most common method available - as in currency swaps.

April Rain said...

Alright, so why is it that the sovereign government of Greece entered into this "currency swap" agreement given that it could pose a very big fat financial problem in the near future?

Ringo said...

Well, April, for most parts, plain-vanilla credit default swaps just represent an ongoing agreement to exchange interest payments in the future, with no exchange of cash up front. But in other instances, the two sides of the currency swap deal agree that there will be an exchange of money up front to one party, who will in the future, pay them back with higher payouts in the future.

April Rain said...

Isn't that essentially sounds like a plain-vanilla loan, Ringo?

Ringo said...

You could be forgiven for making that argument, April, but the thing is, these currency swaps had not been accounted for as loans on the books of the national government. In terms of incentives, the main incentive is that currency swaps gets accounted for in a different way compared to a plain-vanilla loan that allows you to report a lower amount debt on the national level than it actually is.

April Rain said...

So, the fact that Greece apparently had these sort of off-balance sheet loans, accounting-wise, is a big deal? Right?

Ringo said...

Essentially, the currency swap deal between the Greek government and Goldman Sachs raises a lot of questions as to how many banks and how many countries entered into this sort of agreements. The general speculation is that a number of other sovereigns besides Greece did this with other bans besides Goldman Sachs over the years.