Inside the mind of an investment banker: Greece, Goldman and derivatives

By now, you know about the much-discussed swaps that Greece used to conceal it’s debt load.  While the amount of debt concealed is low relative to the total, the mere fact that Greece attempted to conceal its true fiscal position is damning in light of revelations in October that the government’s fiscal hole for 2009 is three times the original April estimate.

The problem is, in a word, credibility. Greece now has none – and this is why its bond yields have skyrocketed.

But what about the investment bankers like Goldman Sachs who helped Greece in its machinations – aren’t they to be vilified as well. What do we do about them? I was thinking about that after an interview I did this morning on Canada’s Business News Network (see clip here). 

Last week, we got some pretty pointed views on this subject. Felix Salmon says “Goldman is a scapegoat.” Yves Smith takes a more negative view of Goldman’s culpability. So I decided to take a different tack and share some thoughts with you on how investment bankers think – and how it may have led to this. I am using this term ‘Investment Banker’ generically to refer to financial staff at broker-dealers whether they work in a sales & trading or an advisory role. This distinguishes the I-Banker from a commercial banker where incentives are somewhat different.

The first thing you have to realize about investment bankers is that it’s all about the money.  Now I’m not talking about a greed is good mentality here. I’m referring to money as validation for achievement, success and self-worth. 

Corporate hierarchies

In a normal corporate environment, there is a strict hierarchy in which those at the top earn more than those at the bottom. In order to rise to the top (and earn the salary and huge bonus – I might add), one needs to be considered successful. And that means putting in years of effort for which one receives performance reviews.

If you do well on these reviews, you might even receive accolades, awards and so on – the point being you are a rising star with talent. So you get promoted. “The way you’re going, you might even rise to CEO one day!” That’s the kind of praise you might hear. So the whole hierarchical apparatus is designed to align high achievement with other external signs of success: good evaluations, promotions, more money, more responsibility, more underlings, larger budgets, awards, and accolades and so on.  All you need to do is look at an org chart and you get a pretty good sense of who’s supposed to be the stars. And by the way, this is how it works in commercial banking as well.

Investment banking hierarchies

But, that’s not how it works in investment banking at all. When one deal or a series of trades can mean billions in profit, even a relatively junior person can have influence on the bottom line far beyond what her title suggests. This is certainly true in the advisory business, but it is even more true in trading – especially proprietary trading, a major reason that proprietary trading is inherently risky and would be restricted under the Volcker Rule. By the way, this is also a major reason that investment banks that are public companies and not partnerships are risky companies with notoriously poor managers.

A slovenly 32-year old junior trader with terrible social skills, zero management ability and no one reporting to him can make millions of dollars a year. He’s the guy you read about in the newspaper making three times the CEO’s salary. He’s the guy that all the other firms are trying to poach. And he’s the guy that used to be referred to admiringly as a “big swinging dick.” You don’t see that at Acme Incorporated. That’s what I mean when I say it’s all about the money.  You learn very quickly in investment banking that status is not all about the titles, it’s more about the money.

Read any account from investment banking like Predator’s Ball or Liar’s Poker you will quickly notice that even the higher level guys are driven to earn a lot of money, not only for the money itself but for what that money says about their status and value relative to their peers.

Advisory business

So, with that in mind, let’s think about the advisory business, Goldman Sachs and the infamous cross-currency swaps. The advisory business is more hierarchical than the sales & trading side of things. But, you can still make a shed load of cash by doing the right deals and being on the right team. Most people in the advisory business work in product or industry groups like Technology or Industrials or Structured Products. In those groups you have some professionals who are product experts while others are relationship managers.

Now, as an individual, your ostensible goal is to serve your clients by giving them the best advice on financial products and transactions to fit their short- and long-term goals. The payoff comes in the form a fee for capital raised, a merger completed or a financial transaction completed. The reality is you as an individual make more money – and hence have higher status – the more transactions you do, the more complex and bigger the deals you do.

So, as an individual there are two major conflicts you might have with your client.

  • If your client wants to do a deal that you don’t think is advisable or ethical; or if you uncover damaging information about your client that makes you believe the terms of a deal need to be altered.
  • If you can arrange a deal that you believe is not in your client’s best interests but which earns your company more money.

Greece wanted these deals

In the case of the cross currency swaps, all available evidence says that the Greeks were actively looking for ways to reduce their apparent fiscal debt levels and deficit numbers without having to reduce spending or raise taxes. It’s called having your cake and eating it too.

So, I imagine Goldman and other banks each had conversations with the Greek government about the government’s financial advisory needs. The Greeks probably said they wanted to have their cake and eat it too and asked if the investment bankers could help them. Now Goldman had a very good relationship manager in the form of Antigone Loudiadis, who had done valuable service for Greece before and had good contacts with the client (exactly what you want in a relationship manager).  According to the Wall Street Journal:

Guided by Ms. Loudiadis in the 1990s, Goldman set up a series of currency "swap" trades for Greece, enabling the country to use favorable exchange rates to record some of its debts. By 2001, when those rates had become unattractive, Ms. Loudiadis helped Greece structure a different trade that enabled the government to continue using advantageous rates for accounting purposes.

So, there’s the basis of what occurred. All of this is well within the norm. 

An alternate view of the deals

But, here’s the problem. There’s another way to look at these deals. Here is the definitive take from a 2003 article in Risk magazine, pointed out by Felix Salmon. I have bolded parts I want to stress:

Ever since the deficit and debt rules for eurozone member states were drawn up in the early 1990s, there have been persistent rumours and allegations that governments have used derivatives to get around them. For some time, economists have argued that the combination of strict external targets with considerable local autonomy in sovereign debt management almost inevitably leads high-deficit countries towards derivatives.

It is now widely known that since 1996, Italy’s Treasury has regularly used swaps transactions to optically reduce its publicly reported debt and deficit ratios. Such trades remain controversial, and were the subject of fierce debate in late 2001, when Italian academic Gustavo Piga published a paper accusing eurozone countries of ‘window dressing’ their public accounts using derivatives (Risk January 2002, page 17).

Now, Italy has been joined by the Hellenic Republic of Greece, as evidence emerges of a remarkable deal between the public debt division of Greece’s finance ministry and the investment bank Goldman Sachs. The deal is not only likely to reopen an old debate on public accounting for derivatives, but also sheds light on the way banks charge clients for taking credit and market risk exposure.

So, Italy played this game as far back as 1996.  And, that’s the crux of the matter. As a banker, you never re-invent the wheel. If a deal works and makes lots of money, you shop that deal around to everyone you can until it doesn’t. If you don’t, your competitors will.  I reckon bankers at Goldman were very excited that Greece wanted to do these deals – and I wouldn’t be surprised if other bankers did the deals or other countries still.

The deal structure

Risk does an excellent job of outlining the structure of the actual swaps.

The transactions agreed between the Greek public debt division and Goldman Sachs involved cross-currency swaps linked to Greece’s outstanding yen and dollar debt. Cross-currency swaps were among the earliest over-the-counter derivatives contracts to be traded, and have a perfectly routine purpose in debt management, namely to transform the currency of an obligation.

For example, an issuer with foreign fixed-rate debt might choose to lock in a favourable exchange rate move. To do this, it could swap a stream of fixed domestic currency payments for a stream of foreign currency ones, referenced to the notional of the debt using the prevailing spot foreign exchange rate, with an exchange of the two notionals at maturity. Because they are transacted at spot exchange rates, cross-currency swaps of this type have zero present value at inception, although the net value (and credit exposure of either counterparty) may subsequently fluctuate.[emphasis added]

Here’s the thing though. As an individual you will always come to a point where a client is you begging you to do something that is legal, makes lots of money for your company, but that you feel is unethical. There had to be a moment in this transaction here.

However, according to sources, 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. [emphasis added]

You get that? Goldman had been doing swaps with Greece in anticipation of Euro entry. These transactions allowed them to take U.S. Dollar and Yen-denominated debt and transfer them into Euros at exchange rates which made the level of Yen/Dollar debt look lower until the swap transaction came due and Greece was forced to make a balloon payment to Goldman.

The morality of all this

What other purpose can these transactions serve other than to mask the true indebtedness of Greece?  Did anyone actually break the law? If these are legal transactions, does Goldman Sachs have any responsibility inform the EU of the deals? Should Goldman’s bankers have refused Greece’s wishes, knowing that some other banker would collect the fees? Why does this matter now other thanregarding Greece’s credibility in future sovereign debt deals?

These are all good questions.  But, the Wall Street Journal article gets to the heart of things and why the deals happened.

Even though the transaction occurred nearly a decade ago, it has come under scrutiny by European Union officials as they examine how Greece fell into such dire economic straits.

Ms. Loudiadis became a Goldman partner in 2000. A cerebral Oxford University graduate, she was eventually named co-head of the company’s investment-banking group in Europe, making as much as $12 million in annual compensation, according to someone familiar with the matter. She lives an exclusive neighborhood in West London known for its white stucco homes.

From a banker’s perspective, that’s what this is all about – money, and the status that goes with it.


Revealed: Goldman Sachs’ mega-deal for Greece – Risk magazine

Also see Tim Iacono’s piece “Playing up to the edge of the line.”

  1. tom griffin says

    Ironic that Ms. Loudiasis’ first name is Antigone. As you recall, Antigone was the product of an incestuous relationship between her mother and brother, King Oedipus.

    Incestuousness may characterize all these Goldman alums holding various governmental positions.

  2. M.G. in Progress says

    Let’s have another perspective. What if:
    The Greek government requested explicitly that kind of swap 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. What’s wrong from their perspective?

    I may add that in the European Institutions (Eurostat and the Commission) some of the officials monitoring the country and/or going on mission to Greece are Greek themselves. Searching on internet you can discover that one was also an ex official of the central bank of Greece.

    It is doubtful that EUROSTAT did not know anything about the swap deal as you have the Greek official there in the team.

    Moreover they are supposed to investigate always those deals as accounting standards before the currency swaps of the Eurostat team that visited Athens in September 2008 to monitor Greece’s debt management” (report at
    “Government expenditure and revenue are reported to Eurostat under the ESA95 transmission programme. They are the
    sum of non-financial transactions of the general government accounts, and include both current and capital transactions. For definitions, see Commission Regulation No. 1500/2000 of 10 July 2000.
    It should be noted that, following an amendment to ESA95, the government balance (which may be calculated as the
    difference between total government revenue and expenditure) is not the same under ESA95 as that of the excessive deficit procedure. Regulation (EC) No 2558/2001 on the reclassification of settlements under swaps agreements and forward rate agreements implies that there are two relevant definitions of government deficit/surplus:
    • The ESA95 definition of net lending /net borrowing does not include streams of interest payments resulting from swap
    agreements and forward rate agreements;
    • For the purpose of the excessive deficit procedure, net lending /net borrowing of general government includes streams of
    interest payments resulting from swap and forward rate agreements.

    1. Edward Harrison says

      It is not clear how much of this was common knowledge – either amongst EU officials or potential investors in Greek sovereign debt. The Risk magazine article does make it appear that there was knowledge that these rules were being flouted via derivatives transaction AND that there was anger because of it.

      Now, I believe the uproar would have been short-circuited if Greece and Italy had been transparent about this, saying in effect “this is legal.” Try and stop us. My colleague Marshall pointed out that there would certainly have been a political backlash in people asking, “Why on earth is the government allowing this sort of thing?” But that is a far superior way of conducting business.

      Certainly, if Eurostat knew about these SPECIFIC transactions and the SIZE of the transactions but chose to ignore it, that’s one thing. Goldman Sachs has no culpability for any of this then. However, conducting these trades in the shadows with no transparency – and with the explicit purpose of flouting the rules of the Maastricht Treaty is ethically dubious.

      I agree with Gerald Corrigan when he says “With the benefit of hindsight, it seems to be very clear that the standards of transparency could have, and probably should have been, higher.” And the fact that it was not will cost Goldman reputationally.

      1. M.G. in Progress says

        How EU institutions could “reasonably” ignore these SPECIFIC transactions and the SIZE of the transactions? They are too big and EU officials dealing with those aspects were Greeks and one was ex Bank of Greece official. I strongly suspect they decided to ignore it and make them “compliant” to get the country into the Euro. It was a political decision that now turns very sour.

        1. Edward Harrison says

          M.G. – You are just making a conjecture. I imagine more details will be forthcoming and we can make a more informed assessment at that juncture.

  3. M.G. in Progress says

    What would you need to know that shows it’s not just a conjecture?

    1. Edward Harrison says

      I don’t understand why you are asking this. A written statement by Eurostat affirming their knowledge of those specific transactions obviously.

      1. M.G. in Progress says

        They made a statement saying exactly the contrary. Can you trust them? That’s politics. What if it is proved that they or some of those EU officials knew?

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