Everyone Was Doing It

By James Kwak

Gerald Corrigan, a Goldman Sachs executive and a former president of the New York Fed, had a curious defense of the Greece-Goldman interest rate swaps. Here are some direct quotations from the Bloomberg story:

“[The swaps] did produce a rather small, but nevertheless not insignificant reduction, in Greece’s debt-to-GDP ratio,” Gerald Corrigan, chairman of Goldman Sachs’s regulated bank subsidiary, told a panel of U.K. lawmakers today. The swaps were “in conformity with existing rules and procedures.” . . .

“There was nothing inappropriate,” Corrigan told Parliament’s Treasury Committee. “With the benefit of hindsight, it seems to be very clear that the standards of transparency could have, and probably should have been, higher.” . . .

Goldman Sachs was “by no means the only bank involved” in arranging the contracts, Corrigan said. . . .

“Governments on a fairly generalized basis do go to some lengths to try to ‘manage’ their budgetary deficit positions and manage their public debt positions,” Corrigan said. “There is nothing terribly new about this, unfortunately. Certainly, those practices have been around for decades, if not centuries. We have to keep that perspective.”

In other words:

  • Governments try to hide their debts.
  • Goldman helped make this possible.
  • Everything was legal at the time.
  • Everyone was doing it.

Corrigan is probably exactly right on all of these points. But this is an admission that banks have been helping governments hide their debts, and a defense on the grounds that everyone was doing it and no regulator complained. (I imagine Goldman must be getting tired of being picked on for simply doing the same things other banks were doing — but making more money than anyone else doing it.) Note, however, that Corrigan doesn’t try to argue that helping governments hide their debts is a good thing.

The underlying problem, I think, is that accounting for derivatives has lagged far behind actual derivatives. I believe that Satyajit Das’s book Traders, Guns and Money (I don’t have my copy with me) has examples of how private companies use interest rate swaps to shift losses from the present into the distant future. If companies are doing this, we should not be surprised that governments are doing it, too. Still, that doesn’t make it right.

16 responses to “Everyone Was Doing It

  1. Felix Salmon makes the good point that “rather small” in this case is 2-3 billion Euros and 1.6% of Greece’s GDP.

    Why do we allow these firms to continue to exist?

  2. WSJ had a profile of the banker responsible for the deal.

    http://online.wsj.com/article/SB10001424052748703791504575079743591308292.html?mod=WSJEUROPE_hps_MIDDLETopStories

    “For Goldman, the trade generated fees of as much as $300 million, according to the people familiar with the matter—a windfall that left traders in the firm’s London marveling at Ms. Loudiadis’ deal-making prowess.”

  3. “In other words:

    Governments try to hide their debts.
    Goldman helped make this possible.
    Everything was legal at the time.
    Everyone was doing it.

    Corrigan is probably exactly right on all of these points.”

    I think that hiding their debts is true in general for governments that are do not have their own fiat currency. (Or have debts in a foreign currency.) The rest have no particular need to do so. (And that is most countries today.)

  4. If everyone really is doing it, I wonder which regulator has an incentive to uncover the practice?

    Perhaps now that it’s been uncovered, some governments will have a sufficient reputational incentive to want to demonstrate that they (and banks under their purview) are not taking advantage of such scams.

    But your example of private companies highlights a more interesting scenario, with clear gains from trade to be achieved.

    In the company example, there will always be someone to take the other side of the trade: for every publicly quoted company that wants to hide its losses, there are dozens of privately owned companies that would love to hide their profits and pay lower taxes.

    Similarly, for every deficit country like Greece that wants to hide its debts, there is a surplus country like China that would be quite happy to reduce the political heat by covering up its accumulated reserves.

    Surely Goldman could be arbitraging between these two – maybe some kind of re-convertible debt-for-equity swap could be arranged – and everyone would be happy.

    (never mind your pedantry about trade surpluses not being the same as fiscal ones. Details, details)

  5. Commenting on Min:
    “I think that hiding their debts is true in general for governments that are do not have their own fiat currency. (Or have debts in a foreign currency.) The rest have no particular need to do so. (And that is most countries today.)”
    I think your statement refers to the ability of any government controlling its own fiat money (currency) to effectively eliminate its typically nominal debt in its own home currency by printing money.
    Which countries have the vast majority of its debt denominated in its own fiat currency ?
    – the US, UK, Canada, Australia and Japan (maybe Norway and Sweden, as well). How will China react, once the US starts inflating, i.e. no longer tries to neutralize its recent money creation ?
    – who controls the amount of inflation in the Euro zone? Is it France or Germany? Aren’t basically all Euro adopters not in full control of their fiat currency, the Euro ? And thus they all have an incentive to hide their debt?
    – typical developing countries tend to have their debt in one of the major reserve currencies, i.e. not in their ‘fiat’ currency. Therefore, don’t they also have an incentive to hide their debt according to your statement ?

    Concluding: the majority of goverments have much of their debt in a fiat currency, which they do not control. And plenty of investment bankers to advise them on this score.
    Not to talk about various regional governments (like the state of California, or a provincial government in Brazil or Argentina).
    So, I am not sure, why your statement would make me feel more reassured.

  6. The Wall Street Journal ran a piece on the SPV used to create the off budget deal between GS and Greece yesterday. The Special Purpose Vehicle was called Titlos as I remember it.( I tossed the paper.) Actually , the transactional chain was not all that complex. I have done quite a few real estate/development/ joint venture deals that were probably more complex. The technique was quite garden variety.

    It really surprises me that all these super educated Herr Doktor’s in European finance did not understand what transactions were taking place. Then, they probably did, but need to head for cover now.

    All that was happening was getting to next year from this year.

  7. So, I don’t get why everyone buys the BS. Does anyone believe fraud ie misrepresenting material facts is merely “inappropriate?” Or that defrauding debt purchasers is “nothing terribly new?” Market participants have been defrauded for decades and somehow the idiots are supposed to purchase debt instruments that have no transparency whether its Greek debt, CDOs, RMBS, or CMOs?
    So what is the motto of the NY Fed: Fraud R US?

  8. WENT THE F**K ARE YOU, on this blog, going to show GOLDMAN SACHS’A GOLD payed only 1% (ONE PERCENT) effective tax in the latest Q report?
    How about the average corporate tax in the 7% (SEVEN PERCENT!) range, that is “effective” in the last few years.
    Maybe you can set the record straight on how LITTLE in taxes US corps are really paying?
    Nobody, I repeat, there is no media covering the EFFECTIVE CORPORATE TAX PAID! That makes you MSM, in my book.

  9. James Kwak writes “an admission that banks have been helping governments hide their debts, and a defense on the grounds that everyone was doing it and no regulator complained”

    What do you mean with no regulator complained? Of course not, they were all in favor of it. They risk-weight government debts at 0 percent when rates AAA to AA- and at 20 percent when rated A+ to A-.

    This meant that a bank could and can have a trillion dollars of public debt without these appearing in its risk-weighted assets and so also without needing one single dollar in equity to back it up with. It was and it is sheer regulatory madness, without anyone saying a word about it… much less complaining.

  10. jessescrossroadscafe.blogspot.com sums it up!>>>

    This Treasury Supplemental Financing Program is designed to provide public funds for the Fed’s efforts to purchase and then liquidate toxic assets and derivatives from the financial sector, effectively absorbing their losses and monetizing them.

    The Treasury creates new notes and sells them on the open market. The money obtained in these sales is deposited at an account at the Federal Reserve. The Federal Reserve uses this money to purchase toxic assets from the banks at its own discretion and pricing, subject to little oversight and market discipline.

    Senator Chris Dodd said “the Fed could become an ‘effective Resolution Trust Corporation,’ purchasing and ultimately disposing of depreciated assets.

    It looks very much like a stealth bailout. It is even more of a scandal because of the Fed’s resistance to any disclosures on the principles and specifics by which they are allocating taxpayer money.

    Where this gets even more interesting is that the Fed in turn is buying Treasury debt after issuance through its primary dealers, debt that was issued by the Treasury to provide funds to the Fed.

    Even more than a stealth bailout, this is starting to smell like ‘a money machine.’ Money machines are what Bernanke euphemistically called ‘a printing press.’ What is odious about this particular printing press is that the output is being given directly to a few big banks by a private organization which they own.

    I believe that it is still illegal, by the letter of the statutes, for the Fed to directly purchase Treasury paper. But in this case, the Fed is buying Treasury paper with money supplied by the Treasury. Since the paper is passing through the marketplace, and the Primary Dealers are taking their commissions, it may be in conformance with the letter of the law. But it looks like it violates the spirit of the law.

    And given that in many cases the Primary Dealers are the principal beneficiaries of the subsidy programs, selling their toxic debt to the Fed at non-market prices, this starts to appear like a right proper daisy chain of self-dealing and fraud.

    As you can see from the background information below, this is a ‘temporary’ program from 2008 that the Treasury keeps promising to ‘wind down.’

    This is not a resolution trust by any measure. One only has to compare what happened with the Savings and Loan Resolution Trust, with the orderly liquidation of assets, losses assumed by the individual banks and their management, and investigations and prosecutions for fraud.

    And the bankers involved in the Savings and Loan bubble and collapse were not still in business and giving themselves record bonuses within twelve months of their collapse, and engaging in the same frauds and speculation that led to the crisis.

  11. Let’s have another perspective. What if:
    The Greek’s governments 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).

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

  12. The underlying problem, I think, is that accounting for derivatives has lagged far behind actual derivatives. I believe that Satyajit Das’s book Traders, Guns and Money (I don’t have my copy with me) has examples of how private companies use interest rate swaps to shift losses from the present into the distant future. If companies are doing this, we should not be surprised that governments are doing it, too. Still, that doesn’t make it right.

    So there’s another reason we (and prospective investors, too) should consider all alleged reported “profits” potentially bogus.

    So piece by piece the picture resolves. The finance sector’s activity is meant to help corporations and governments cover up for the fact that it’s been many years since there’s been real “growth”, and most large entities are in the red if not insolvent.

    This pandemic control fraud is covering up for the structural collapse of the debt economy, resource depletion, and the fact that much of what wealth still exists is now being flat out embezzled from society by a handful of gangsters.

    The gangsters, in corporate and governments, engage in this control fraud to pretend the money is still there and growing. That’s the nominal fraud mode.

    Whenever they get caught because a ponzi scheme blows up, as with mortgages in the general example of 07-08, or as in more specific examples like Greece or a particular TBTF bank, we have the disaster capitalism mode. The system pretends the blowup is some kind of act of God, force majeure that’s nobody’s fault. It’s also considered an act of God who has decreed that the rich who benefited from the bubble don’t have to divest themselves to cover the losses now that all those “profits” have proven to have been fraudulent.

    Nope, the religion says that money is untouchable, sacrosanct. Rather, all the pain must fall on the same people who were looted the first time around. They must undergo “austerity”, be “adjusted”.

    And all in order to prop up the fiction of the original fraud, and to enable that looting to continue.

    This is a capital crime, history’s worst ever. We need a second Nuremburg.

  13. “The system pretends the blowup is some kind of act of God, force majeure that’s nobody’s fault. It’s also considered an act of God who has decreed that the rich who benefited from the bubble don’t have to divest themselves to cover the losses now that all those “profits” have proven to have been fraudulent”.

    You are right. Then you have legal experts discussing whether the European Union could refer to an article in the Lisbon Treaty to provide assistance to Greece and whether Article 122 of the Lisbon Treaty would be valid for Greece. The article says that EU members states that are “seriously threatened with severe difficulties caused by natural disasters or exceptional circumstances beyond its control” can be granted financial assistance “under certain conditions”. Article 122 has to be interpreted as ” some kind of act of God, force majeure that’s nobody’s fault”…What a shame…

  14. The fact that systemically important financial institutions have a de facto government guarantee, means that the money is not earned by the manufacturing of goods, but by speculation. The financial sector has total freely not only animated the private sector to make bets by using exotic financial products on rising house prices, but also helped governments to disguise the real value of debt with interest rate swaps . The banking sector obviously has fallen completely out of control. What urgently needed is, banks, which offer the services for the national economy needed, such as loans, foreign exchange, export financing, etc. for firms to make investments in the real economy.

  15. Everything may not have been legal at the time if disclosure obligations were not met or if the EU or investors were misled. For example, if GS did this type of transaction with a public company in the US, and the company failed to disclose the material impact and the fact that future revenues had been pledged and therefore would not be available in the future to meet other obligations, one could certainly make the case the company engaged in securities fraud. One might be able to make an aiding and abetting case against an investment bank that engaged in the transaction knowing that the company intended to mislead the market. A tough case, but not impossible. See AIG.

    In any event GS has proven itself the financial equivalent to an international terrorist organization. We need to find a financial equivalent to Gitmo.

  16. goldman sachs needs to be stigmitized as the failed bank of the past… shrouded in incongruent baseless episodes of trading… existing only to fail the market