Goldman under scrutiny for its role in Greece's fiscal woes

McClatchy NewspapersFebruary 25, 2010 

WASHINGTON — Federal Reserve Chairman Ben Bernanke Thursday said that the central bank is examining investment titan Goldman Sachs' use of exotic financial instruments to profit from the deepening debt problems of Greece and other European nations.

A separate Securities and Exchange Commission inquiry into the "destabilizing effects" of Wall Street's use of derivatives also appears certain to include Goldman's dealings.

The revelations came as Democratic Sen. Christopher Dodd of Connecticut, the chairman of the Senate Banking Committee, questioned Bernanke during a hearing on monetary policy. Bernanke said that Goldman and other banks are being looked at for their use of insurance-like contracts called credit-default swaps to profit when foreign governments slide toward defaulting on their debt.

Investors used these swaps, which were like gasoline on fire during the near meltdown of U.S. financial markets in September 2008, to hedge against the risk of losses from a debt default. For countries such as Greece, however, they also raised borrowing costs, making it harder to prevent a default.

"Since there is no requirement that purchasers of credit default swaps actually own any of the underlying debt, we have a situation in which major financial institutions are amplifying a public crisis for what would appear to be . . . private gain," Dodd told Bernanke. "I want to ask you here whether or not you think there ought to be limits on the use of credit default swaps to prevent the intentional creation of runs against governments."

"I just want to say first of all that we are looking into a number of questions related to Goldman Sachs and other companies and their derivatives arrangements with Greece and on this issue as well," said Bernanke, who's attempting to show Congress that the central bank can be an effective regulator.

"Using these instruments in a way that intentionally destabilizes a company or a country is — is counterproductive, and I'm sure the SEC will be looking into that," he said. "We'll certainly be evaluating what we can learn from the activities of the holding companies that we supervise here in the U.S."

Goldman is under fire because of disclosures, initially in the German magazine Der Spiegel, that it used another derivatives product, called currency swaps, to help Greece hide the size of its debt in 2001, and then allegedly used credit-default swaps to bet that the country would default.

Goldman spokesman Michael DuVally said Thursday that Goldman managing director Gerald Corrigan notified the regulatory agency Eurostat "in principle" of the firm's plans to assist an unidentified European government with currency swaps before executing the transactions and received no objection.

Published reports have quoted Eurostat, based in Luxembourg, as saying that it was unaware of Greece's arrangement with Goldman.

DuVally denied that the firm's bets comprised a major portion of the outstanding swap bets on Greece's debt, a figure that stood at $84.8 billion in February, according to data from the Depository Trust & Clearing Corp., which monitors the private, unregulated trades.

"Conspiracy theories or reports that suggest Goldman Sachs is engaged in trading activities to massively short Greece's sovereign debt are misguided and just plain wrong," DuVally said.

Sylvain Raynes, a frequent Goldman critic who's an expert on swaps, said that by assisting Greece in hiding its debt, Goldman behaved like the family of an alcoholic concealing his addiction while simultaneously obtaining "inside information on what's going to happen."

Raynes, who worked briefly for Goldman, called the Greece episode "a repeat of Goldman betting against its customers" in the subprime mortgage market while becoming the only major Wall Street firm to make a tidy exit before the U.S. housing crash. "Nothing is perfect, but we have to stop the boundless volatility possibilities of the credit-default swap market," Raynes said.

McClatchy first reported in November that Goldman had sold more than $40 billion in risky mortgage securities in 2006 and 2007 while secretly betting that the housing meltdown would cause their value to plummet.

Goldman has said that it made the vast majority of its swap trades on behalf of its clients, but has never spelled out how much it reaped from proprietary bets.

SEC spokesman John Nester said that he could neither confirm nor deny a formal investigation. However, he said that various kinds of swaps are under scrutiny.

"As an agency, we have been examining potential abuses and destabilizing effects related to the use of credit-default swaps and other opaque financial products and practices," Nester said. "Chairman (Mary) Schapiro has advocated closing the current regulatory gaps and bringing these instruments under the regulatory umbrella."

McClatchy reported in December that the SEC was investigating Goldman's securities sales in the Cayman Islands.

As part of a broader revamp of financial regulation being debated in Congress, legislation is expected to force credit-default swaps and other so-called derivatives transactions onto exchanges or clearinghouses where there would be greater transparency and recognized procedures for settling exotic bets in an unregulated global market that's valued at $50 trillion.

"Due to the potential cascading harm that these instruments can inflict upon financial systems, we continue to work with Congress to pass strong comprehensive over-the-counter derivatives legislation," the SEC spokesman said.

WHAT ARE CREDIT DEFAULT SWAPS?

Few areas in finance are as complicated as derivatives, which are private bets between two or more parties that aren't carried out on a public exchange as stock or bond transactions are.

Credit-default swaps involve an investor paying a trading partner for "protection" against default and receiving a large payoff should a bond issuer default on payment. Part of what the Fed and SEC are looking at are "naked swaps," when a bet is made that a company or country may default on its debt even though one or both parties have no stake in the underlying asset. In this case, the investors wouldn't actually own bonds issued by Greece, but only would bet on their performance.

Reports of Goldman's maneuverings with Greece have put the spotlight on four high-debt European governments — the so-called PIGS: Portugal, Italy, Greece and Spain.

"You can describe it as 'creative accounting' or 'cooking the books,' depending on which side you are on," said a Greek diplomat, speaking on the condition of anonymity because he wasn't authorized to discuss the affair.

In February, outstanding credit-default swaps totaled $230.8 billion on Italy's debt, $109.7 billion on Spain's and $64.1 billion on Portugal's, according to the DTCC.

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